It all started with irrational exuberance

The “dot-com” boom and subsequent bust in the late 90s and early 2000s, best characterised by the now popular ‘irrational exuberance’ phrase coined by Federal Reserve Chairman Alan Greenspan, is the clearest example of the volatile relationship investors have had with tech stocks. More recently, the sector’s relatively modest fall from grace after driving broader market returns in 2018 has certainly rankled investors, but it has been a far cry from the fire-sale of 2000.

However, the tech story is broader than just the extreme valuations of anything with ‘.com’ in the name back in 2000, or the visions of Zuckerberg and Bezos today. Underpinning the story is the technology of semiconductors, and the direction of this technology is at least as important for the tech sector in the long-term as the latest trends in Instagram marketing.

Semiconductors are the building blocks for 21st century growth

The importance of semiconductors is easy to overlook, as we see the end result of their use rather than the physical object. But they are key components in the electronic devices which form an integral part of our daily lives. Put most simply, it is the advancement in semiconductor technology that is responsible for all of us having a supercomputer in our pockets at all times.

This rapid advancement in the technology was predicted by Gordon Moore of Moore’s Law fame, who posited that the components on an integrated circuit would double every two years. This was something of a self-fulfilling prophecy for the industry, and made research and development spending in the sector generally more predictable. But as it usually does, physics is getting its revenge. The ability of the silicon age to progress exponentially is fading. Machine learning is emerging as a ‘new frontier’, but its potential has yet to be proven.

Semiconductors are often referred to as the building blocks for growth in the 21st century, much like steel’s integral role in industrial production beginning in the late 19th and 20th century. But just as steel didn’t have solely commercial applications, and allowed for the industrialisation of warfare, there is a disquieting side to semiconductors as well.

Source: Refinitive, Fidelity International, January 2019.

The other side of the semiconductor story

While news headlines on the US/China trade wars often focus on US President Donald Trump’s tweets, rotting soybeans, and iPhones, we should not forget the newest semiconductor technologies will likely underpin a revolution in military affairs characterised by robotics and the internet-of-things.

While battling China is increasingly synonymous with Donald Trump, the bipartisan nature of this dispute is evidenced by one of the Obama administration’s parting shots in January 2017. A report by the President’s Council of Advisors on Science and Technology argued for the continued US leadership in semiconductors for both economic and national security reasons, in the face of Chinese plans to expand their capacity, “motivated by economic and national-security goals.” Current Chinese semiconductor technology is not state of the art, but upscaling their productive capacity is a key component of their lofty China 2025 plan, which the US has taken issue with. All this speaks to the true nature of the trade dispute: it is not just Trump and the Republicans, it is not just about the trade deficit, and this is not going away anytime soon.

At this juncture, investors are asking if this is the end of the tech trade. Given the long memory of investors scarred by the ‘dot-com’ bust, and the strong upward march of US tech stocks since mid-2017, it makes sense to ask that question, especially given the large weighting of technology stocks in major indices. But it is clear the tech story is not going away, and investors are married to it, whether they like it or not.

*Originally published by Money Marketing on 14 Jan 2019.

Bill McQuaker

Bill McQuaker

Portfolio Manager, Fidelity Multi Asset

George Watson

George Watson

Investment Writer