Market weekly – Remodeling tech: Innovation and regulation (learn or pay attention)
Read the article or listen to the podcast with Lead Portfolio Manager Pamela Hegarty for Disruptive Technology Strategy.
There are clear opportunities across the sector, though valuations of technology stocks have more than doubled from the pandemic lows of last March, when technology emerged in response to many of the virus outbreak’s challenges.
Admittedly, the ratings seem excessive in certain areas, but overall there is still room for positive performance in a multi-faceted area ranging from cloud computing and artificial intelligence (AI) to robotics & automation to the Internet of Things.
We should note that the IT sector is currently trading at 1.26 times the forward price / profit compared to the S&P500 index. That is above its long-term median of 1.15x, but well below the 2.2x peak value during the Internet bubble and its aftermath.
We believe the sector stands out given expectations of strong long-term growth.
IT spending is forecast to grow 9% this year and 5% in 2022 (source: Gartner), with spending on cybersecurity, cloud migration, collaboration, and data analytics expected. The Biden government’s multi-billion dollar spending plans add to the bright outlook focused on 5G, broadband access and alternative energy in the US.
Semiconductor boom – a super cycle
At the same time, from my point of view, the semiconductor segment is currently in the early to middle phase of a super cycle that could last three years or more.
This super cycle is being driven by strong secular growth in technology. The reports are currently focusing on bottlenecks – in certain types of semiconductors such as microcontrollers – and the storage and production problems they cause in companies such as the automotive industry, computers and smartphones.
In the long run, however, this is a segment whose technology is fundamental to enabling cloud computing, AI, automation and robotics, and the Internet of Things. As such, it benefits from robust demand in all end markets (be it automotive, industrial, or the more traditional IT and smartphone markets).
Capacity building – as planned in the US and Europe to reduce reliance on overseas sources – will take some time, so we are cautious about the scope for mid-cycle correction, but our overall view is is positive for semiconductor capital goods and suppliers of specialty materials.
Fintech innovation – cryptos, DeFi and NFTs
The constant further development of the tech sector is currently nowhere more evident than in the fintech sector. Blockchain is probably the fastest developing area of innovative technology here today, but there are also major advances in digitization, payment technology and fraud prevention.
Blockchain has significant uses in a number of areas. This database technology, or Distributed Ledger, enables cryptocurrencies, but also decentralized finance (DeFi) and non-fungible tokens (NFTs) – all rapidly developing areas that use non-traditional platforms, often apart from the typical central intermediaries such as regulated exchanges or monitored banks and Estate agents.
In cryptocurrencies, we are seeing a trend away from bitcoins on the issue of its quality as a store of value due to a lack of support or collateral.
You can see a shift in markets towards stable coins backed by physical assets and government-issued cryptos – central bank digital currencies (CBDCs). These can be viewed as fungible tokens – one token is essentially exchangeable for another.
Regardless, there is the advent of NFTs – a data set (code) that certifies the uniqueness and ownership of a digital asset. The asset can be, for example, a work of art, a financial contract or sports memorabilia, but also goods that flow through the supply chain. Given the active innovation in this area, we believe this is an important space to watch out for future developments.
The value of this – loosely regulated – growth market has grown rapidly – from 250 million US dollars in 2020 to over 2 billion US dollars in the first quarter of 2021. 
These are fascinating areas that have the potential to change the landscape for traditional players, not just in the financial services sector. However, there are also concerns about consumer protection and the fight against abuse and criminal use. The inherent lack of oversight, which reflects the decentralized nature of these products, can open them up to money launderers and financiers of illegal activities.
Platforms, exchanges and marketplaces that get into regulated areas can face control by supervisory authorities. A crypto exchange that offers loans or other types of securities should expect financial regulators to investigate or possibly issue a ban.
Controls and concerns about criminal exploitation could slow the development of the blockchain over time and affect the process of selecting winners and losers.
Regulation – More of an issue in China than the US
We have also seen increased regulation and oversight in other technology areas such as social media.
In the US, Democrats and Republicans are considering tighter regulation of technology for their own reasons. Democrats are concerned about issues such as market power and abuse, and consumer protection, while many Republicans share these concerns but are also concerned about the liberal bias of the major social media platforms.
We will be watching with great interest the progress of the various bills that will be introduced into US legislation. It is difficult to estimate the likely outcome. Nor can we accurately estimate how long the legislative process might take. In the short term, however, I don’t expect much development.
More importantly, we’ve seen regulatory measures in many areas in China, including e-commerce (apps), digital payments, and games. This has weighed on the markets in the past few weeks. We expect more regulation from internet companies, for example.
The authorities have raised concerns about data security, national security and demographics, but are also trying to ensure common prosperity by closing the prosperity gap and addressing excesses seen as excesses in areas such as transportation, food delivery and private education.
We work closely with colleagues on the China Equity team and the Emerging Market Equity team to assess the impact on our investments.
In the end, we expect Beijing to continue to strike a balance between innovation and regulation, but in the meantime, our teams are considering gradually shifting to less targeted industries like IT services and semiconductors. We see this as a bigger problem for the market than a possible US regulation.
In my opinion, all these developments underscore the need to follow this very dynamic sector closely and critically and to actively manage all investments while keeping an eye on its long-term potential.
 NFT sales top $ 2 billion in Q1, with twice as many buyers as sellers https://www.cnbc.com/2021/04/13/nft-sales-top-2-billion-in-first- quarter-with-interest-of-newcomers.html
All views expressed here are those of the author at the time of publication, are based on available information and are subject to change without notice. Individual portfolio management teams can have different views and make different investment decisions for different clients. This document does not constitute investment advice.
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