Tech stocks have been severely underwater over the past two months this year, even though the fundamentals behind many of the names really haven’t really changed that much. We believe that the tech sell-off is overdone, and that two sectors – Cyber Security and Cloud Computing – will be the dominant themes for 2019.
Analysts out there have their own views of why the latest selloff has happened. In this post, we’ll take a closer look at differing analyst views to find out if investing in Cyber and Cloud makes sense for 2019.
So, what really happened to tech stocks over the last few months? Well…one view is that the trade wars heated up. This belief holds that the Sino-US tensions resulted in doing damage to tech names, including those in the Cyber Security and Cloud Computing sector. Let’s look at this view a bit closely.
To do that, we’ll take Microsoft (MSFT) as an example. One estimate has the tech giant, who has made giant strides into cloud computing, earning about 10% of its revenue from China. On the other hand, former MSFT CEO Steve Ballmer indicates that for every 100 companies that use MSFT products, only 1 pays for them! According to Mr. Ballmer, MSFT has a 90% saturation among Chinese corporations – so the IP theft is actually taking a huge bite out of MSFT potential China-related revenue. That would imply that the tariff wars should (theoretically) have had a material impact on the company’s share price.
But as we look at a 1-year chart above, MSFT shares are up over 15% since late 2017. Most of the other major players in Cloud and Cybersecurity have fared equally well, if not better! So, the view that the trade wars are solely to blame for the equity market collapse doesn’t hold water. Still, holding a broad basket of individual and ETF cloud-computing and cyber security names in a portfolio, over a 1-year period, would have yielded an enviable 10% return to investors.
Other analysts look at the rout in the tech space and take a different view of the underlying cause. This camp believes that the “tech wreck” is merely a manifestation of the malaise that we see in the broader economy. The fact that major indices (even non-tech-heavy ones) are down lends credibility to this alternate view.
Let’s for a minute assume that the “tech wreck” didn’t happen. Obviously, we can’t roll back the clocks to make it so. But if we “erased” the destruction from the last two months (Nov and Dec), and went back to see how the markets would have looked on Oct 31, 2018, we’d see a whole different picture.
Taking MSFT as our example again, our holdings in the name would have been 25% higher than from the start of the year. That same portfolio of cyber security and cloud computing names would have yielded us +23.5% return (versus +15% just 2-months later). This reasoning leads us to believe that, despite the spiraling downturn in tech names broadly, specific sectors like Cyber and Cloud will have a big turnaround in 2019 – once the trade war cools off.
The turnaround portfolio
Technologies such as Software as a Service (SaaS), Data as a Service (DaaS) and the Internet of Things (IoT) have just started taking off over the last few years. Along with Microsoft Azure and Amazon Web Services, many other players (including International Business Machines (IBM), Oracle Corporation (ORCL) and Salesforce.Com (CRM)) offer cloud products, services and solutions globally. And all that data and infrastructure needs protecting!
Research firm Gartner believes that the size of public cloud service revenue is set to explode from $186.4B in 2018 to $221B, $260B and 302B in 2019, 2020 and 2021 respectively. That suggests a nearly 18.5% average increase over the next three years. So, what of the prospects of cybersecurity companies? What do they stand to gain from the explosive growth in cloud computing?
One recent report on the future of cyber security suggests that this market is expected to grow from $153B in 2018 to $248B by 2023. That’s a compounded annual growth of over 10%. All the companies on our list are set to participate in the significant growth in the twin sectors of Cyber and Cloud.
Clouds of China-U.S. trade tensions are bound to blow away sooner rather than later, perhaps in the early part of 2019. China appears to already taking some steps to address the most pressing of those issues – IP theft. China has also announced a reduction of tariffs on U.S-manufactured cars. And there are reports that China has agreed to import more soybeans from the U.S. Clearly, the temperatures in the trade wars seem to be cooling down.
So, what would our “ideal” 2019 Cyber and Cloud portfolio look like?
If we whittled down our list of names to just seven of the better-performing stocks from the broader list, that would still have given us a 19% plus return. We’d still have market leaders in the Cyber world (like SPLK, VMW and FTNT) and giants in the Cloud world (AMZN, MSFT and CRM). We’d even have cloud/cyber infrastructure players like CSCO in the portfolio.
If you are someone that’s concerned about owning individual names, or worried about what trading fees could do to portfolio returns, then perhaps the ETF route might be the way to go. Both HACK and SKYY contain a broader basket of cloud and cyber players, including many of the names proposed here. With Management Expense Ratios (MERs) of 0.60% each, they aren’t that expensive to own, and will add significant tech diversification to any 2019 portfolio.
Author does not have investment in stock discussed in this article.