Defensive Technology

• The S&P 500 and Nasdaq 100 both closed down 0.1% on Friday, just below their record highs, while the Dow edged up slightly.

• Markets were assessing the latest economic data and the sustainability of the AI-driven rally this year.

• Apple fell 0.4% amid withholding AI software upgrades in the EU due to regulatory concerns.

• Conversely, consumer discretionary sector led the gains, boosted by a 1.6% rise in Amazon.

• Communication services also was in green with Alphabet up 1.4%.

When investors have conviction, they generally are willing to invest. When conviction is lacking, it is hard to act.

This year, investment bank strategists have lacked conviction - the best recent example of this is Goldman Sach’s S&P 500 end-of-year valuation forecast released last week;

• The base case is 5,600, up about 1.8% from current levels.

• Their range of possible outcomes is 6,300 on the high end and 4,800 on the low end.

Essentially, their outlook is the market could be up 15% or down 13%, but because they have little conviction, they forecast almost unchanged by year-end.

The one investment where investors seem to have high conviction is large-cap, technology stocks. In an uncertain investment environment, large-cap tech has become the new “defensive” play.

A couple of decades ago, when technology was a much smaller part of the overall economy, technology stocks were viewed as somewhat speculative. Technology is now a major portion of the overall economy - mega-cap technology companies are essentially monopolies.

Mega-cap technology companies are high-margin, cash-rich companies with secular growth drivers that should outperform in a recession. Consensus expects Microsoft, Meta, Amazon, Oracle and Alphabet (Google) to spend about $181 billion on Capex this year, corresponding to +36% year-over-year growth rate and over 8x growth in the last decade.

From 2004 through 2009, Capex spending by these five companies showed zero growth. The pace of growth has accelerated since then - $4 billion in spending is now $181 billion. Both the capacity to spend this much and the benefit of receiving this much go a long way to explaining how the large-cap technology sector has become the new defensive sector.

Since the broad market low on March 9 '09, the S&P 500 has surged 709% as of June 20, 2024 (chart below). Cyclical sectors, led by information technology and consumer discretionary stocks, have outperformed, while all four defensive sectors lagged behind.

When spending on technology by just these five companies is this large and rising at such a fast pace, it is not hard to imagine how Nvidia can become the most valuable company in the world.

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