The relative performance of US equities and the outlook for the Technology sector are closely aligned. This short note aims to highlight headline risks that the Technology sector may face in 2021. When allied to high valuations, these risks have the potential to impact relative performance not only of the Technology sector, but also of the S&P 500 itself.
The Tech sector is 27% of US equities and approaching 10% in Europe. Given its scale in the US, the outperformance of Technology has propelled the outperformance of US equities globally. Similarly, a weaker outlook for Technology could hold back US equities in relative terms.
We find valuations for the sector today more than reflect the earnings trajectory for the majority of listed companies. Valuations have risen sharply over the last four years, both in the US and in Europe:
Yet headline risks appear to be rising. Below we highlight five policy risks that may crystallise in 2021:
- A Global Digital Tax. The OECD is leading global negotiations for a global digital tax. Details of this tax may appear as early as this April with more comprehensive details due in July. In late February, US Treasury Secretary Janet Yellen removed the Trump administration’s previous obstruction to an agreement, paving the way for the new tax to be implemented.
- Anti-Trust Investigations. Biden is assembling a team at the Federal Trade Commission and the National Economic Council who are arguing for a break-up of the Big Tech platforms. The European Union has already filed a series of anti-trust investigations into Big Tech and the UK’s Competition and Markets Authority has stated it is soon to follow.
- Increase in Corporation Tax. An increase in the US Corporate Tax Rate from 21% to 25% is likely under the Biden administration. Whilst this does not single out the Technology sector, it will impact highly valued securities the most. The higher the valuation, the longer the duration of future cashflows, the larger the valuation impact of tax changes.
- Increase of US Tax on Foreign Sourced Revenue. Today foreign sourced revenue faces a tax rate of 10.5%. Biden has proposed increasing this to 21%. The Tech sector is the largest earner of foreign sourced revenue and so would be disproportionately impacted.
- Increase in Capital Gains Tax. Biden has stated he wants capital gains tax to be moved in line with income tax and set at 40%. Whilst a move to 40% will be politically difficult to implement, an increase from today’s 15-20% rate to 25-28% is possible. Investors sitting on large capital gains will be incentivised to sell ahead of such a change. The Technology sector, having had excellent stock market performance and high retail investor participation in recent years, may face heavier selling than other sectors.
Many of these policy risks are US centric, but they are following a global pattern. This is not just a US and European phenomenon. In China, Tech investors have been surprised at the scale of regulatory interference in recent months. The reason for these announcements is that the political reality has changed. The Tech sector has operated in a regulatory blank space for the last decade. This had allowed for outsized returns. But no longer. Policy makers and regulators have the sector in their sights. Valuations do not reflect these changing risks.
The proposed tax changes in the US not only impact Technology, but also the relative attractiveness of US equities. Higher taxes reduce post tax returns. Heavy weightings in US equities may seek other destinations, including Europe. This shift has the potential to improve the relative performance of global ex-US equities and perhaps weaken the US Dollar.
The LF Lightman European Fund remains cautious of the Technology sector in 2021. The combination of rising bond yields, rising taxes, political interference, heavy professional and retail investor allocations – and full valuations – suggests a deteriorating risk reward for the Tech sector. This development has the potential to spill over into relative weakness for the S&P 500. European equities have the potential to be a relative beneficiary from this change in fundamentals.
Sources: Lightman, Strategas – March 2021
Risk: Past performance is not an indicator of future performance. The value of investment might fall as well as rise.
This document is owned by Lightman Investment Management Limited (“Lightman”, “we”, “us”). Lightman Investment Management Limited (FRN: 827120) is authorised and regulated by the Financial Conduct Authority (“FCA”) as a UK MiFID portfolio manager eligible to deal with professional clients and eligible counterparties in the UK. Lightman is registered with Companies House in England and Wales under the registration number 11647387, having its registered office at c/o Buzzacott LLP, 130 Wood Street, London, United Kingdom, EC2V 6DL.
This document is intended for ‘Eligible Counterparties’ and ‘Professional’ clients only, as described under the UK Financial Services and Markets Act 2000 (“FSMA”) (and any amendments to it). This document is not intended for ‘Retail’ clients and Lightman does not have permission to provide investment services to retail clients. Any marketing document is only intended for ‘Eligible Counterparties’ and ‘Professional’ clients in the UK, unless it is being used for purposes other than marketing, such as regulations and compliance etc.
Collective Investment Scheme(s):
The collective investment scheme(s) – LF Lightman Investment Funds (PRN: 838695) (“UK OEIC”, “UK umbrella”), and LF Lightman European Fund (PRN: 838696) (“sub-fund”, “UK product”) referenced in this document are regulated collective scheme(s), authorised and regulated by the FCA. In accordance with Section 238 of FSMA, such schemes can be marketed to the UK general public. Lightman, however, does not intend to receive subscription or redemption orders from retail clients and accordingly such retail clients should either contact their investment adviser or the Management Company Link Fund Solutions (“Link”) in relation to any fund documents.
The collective investment scheme(s) – Elevation Fund SICAV (Code: O00012482) (“Lux SICAV”, “Lux umbrella”), and Lightman European Equities Fund (Code: O00012482_00000002) (“sub-fund”, “Lux product”) referenced in this document are regulated undertakings for collective investments in transferrable securities (UCITS), authorised and regulated by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg. In accordance with regulatory approvals obtained under the requirements of the Law of 17 December 2010 relating to undertakings for collective investment, the schemes can be marketed to the public in Luxembourg and Norway. Lightman, however, does not intend to receive subscription or redemption orders from any client types for the Lux product and accordingly such client should either contact their investment advisor or the Management Company LINK FUND SOLUTIONS (LUXEMBOURG) S.A. (“Link Lux”) in relation to any fund documents.
Accuracy and correctness of information:
Lightman takes all reasonable steps to ensure the accuracy and completeness of its documents and its contents; we however request all recipients to contact us directly for the latest information and documents and issued documents may not be fully updated. We cannot accept any liability arising from loss or damage from the use of this document
Wherever the document refers to a third party such as Link, Northern Trust etc., we cannot accept any responsibility for the availability of their services or the accuracy and correctness of their content. We urge users to contact the third party for any query related to their services.
Important information for non-UK or non-EEA persons (Including US persons):
This document is not intended for any person outside of the UK or the European Economic Area (EEA). Lightman or any of the funds referenced on this document are not approved for marketing outside of the UK or the EEA. All non-UK and non-EEA persons must consult their domestic lawyers in relation to services or products offered by Lightman.
Risk warning to all investors:
The value of investments in any financial assets may fall as well as rise. Investors may not get back the amount they originally invested. Past performance is not an indicator of future performance. Potential investors should not use this document as the basis of an investment decision. Decisions to invest in any fund should be taken only on the basis of information available in the latest fund documents. Potential investors should carefully consider the risks described in those documents and, if required, consult a financial adviser before deciding to invest.
Offer, advice, or recommendation:
No information or document on this document is intended to act as an offer, investment advice or recommendation to buy or sell a product or to engage in investment services or activities. You must consult your investment adviser or a lawyer before engaging in any investment service or product.
The content on this document cannot be distributed or reproduced without our consent.