Technology companies have made a permanent mark, both in our day-to-day routines and also on the global stock markets. By its nature technology is innovative, has the potential to disrupt the status quo, and can gain a global reach relatively fast.
Companies successfully offering technology services or products have experienced tremendous growth both for themselves and their investors. However, the pendulum has now swung and the swift success of technology companies – and in particular, the resultant market capitalisation (size) of certain companies – introduces a heightened risk that must be balanced against their obvious allure.
The inherent volatility of tech stocks
Ignoring technology as an investment strategy would likely be to the detriment of your balance sheet, however, being too aggressive in your embrace of them may not produce the outcome you expected. This is simply because while these companies offer growth and the potential for fast expansion, they are also at the forefront of innovation. The very nature of innovation implies that a product can become redundant overnight if a better competitor enters the market.
As a result, technology stocks are notorious for their volatility and the overall proportion they occupy in your investment portfolio should be balanced accordingly. And while one may feel that a huge company is too big to fail, the very size of these companies presents investment strategy challenges, too.
Risk due to size
Within the entire population of listed technology companies, there are those which are household names and this group is known in the investment circles as the Magnificent Seven, namely: Google, Amazon, Apple, Meta (Facebook), Microsoft, Nvidia and Tesla.
To put into perspective the overall size of these companies, we can look at the MSCI All Country World Index (ACWI). The MSCI (ACWI) is a stock index designed to track broad global equity-market performance. It is maintained by Morgan Stanley Capital International (MSCI), and the index comprises the stocks of nearly 3000 companies from 23 developed countries and 25 emerging markets.
Technology stocks make up about 22% of the market, which in itself is not too alarming. However, that 22% is largely made up of the Magnificent Seven, so you will recognise their potential to skew things.
When you compare the value of these companies to the value of the GDP of some extremely successful countries’ economies, you see an interesting picture and gain perspective on how large these companies are. If you add the value of the economies of China, the United Kingdom, Japan, and France together, they almost equate to the total market capitalisation of the Magnificent Seven.
To add further perspective for us as emerging markets investors, the total market capitalisation of the Magnificent Seven amounts to approximately twice the size of South Africa, India, Brazil and Russia’s economies combined.
Where to from here?
We have not seen the end of the growth in the technology sector, not by a long chalk. Driven by the growth in the Artificial Intelligence (AI) sector, investors have embraced the Magnificent Seven with enthusiasm this year, resulting in their earnings making up more than 75% of the total returns of the MSCI ACWI for the first half of 2023.
This is despite the fact that their revenue had only increased by 2.7%: investors are investing in the potential of expected future returns, not current earnings. The potential for volatility is obvious.
Keeping a cool head
As always, keeping your long-term goals in mind and applying a diversified strategy will pay its own dividends.
While spreading some of your investment portfolio across sectors such as healthcare, consumer goods, financials, commodities, cash, bonds, and property may not always get you the best return if technology outperforms the market, the opposite is also true. A balanced approach that takes into account your individual financial needs, as well as your risk appetite, is not only more palatable but is likely sufficient to meet your long-term needs while enjoying a less stressful journey along the way.
Speak to your CERTIFIED FINANCIAL PLANNER® professional at your next annual review about whether or not you need to rebalance your investment portfolio to take into account your technology exposure.
By Ryan Winter, CFP®