The broad inter-correlated market movements broke down in 2020
The US stock market is not a monolith. When the stock market is up, any individual company stock might be down, and vice versa. It all depends on the correlations between an individual company and the market in general. The trends that affect different types of business – the underlying sectors in the marketplace – quickly demonstrate that similar businesses tend to move in tandem. As a result, market analysts tend to consider the performance of business sectors, looking for clues as to how the economy is doing and where we are on a business cycle.
It has been many years since Westminster Consulting has written an article focused on highlighting individual sectors. For example, we had an article in December 2012 on the Housing market since it was the epicenter of the latest financial crisis. Similarly, we had an article in December 2014 on the Energy Sector because the falling price of oil was having a widespread suppressive impact on earnings. However, over the past six years, there have been fewer reasons to highlight individual sectors. The correlations between market sectors had been, prior to the March COVID crash, high and stable. In other words, the stock market has been marching steadily higher across most sectors for years and there wasn’t an inordinate difference between sector performance for well diversified investors.
That all changed in March 2020. When everyone is stuck at home during a quarantine, fuel consumption plummeted, and the energy sector took a nosedive. Despite partial recovery, the energy sector is still down 42% for the year. In contrast, some sectors - like communication services and information technology - saw increased utilization during the quarantine and these sectors continue to operate at an elevated level given the diminished mobility of American families. In performance terms, the information technology sector is up about 39% for the year at present.
At a more granular level, business sector activity is split into different industries, and the March COVID crash (and public response) produced wildly different results across these industries within the same business sector. For example, the Consumer Discretionary business sector represents purchases which are desirable, but not essential. Some of the underlying industries within the sector - like the underlying Hotels, Restaurants, and Leisure industry - were deeply damaged by the COVID crash. Conversely, internet retailers soared as American’s looked for shopping and entertainment options at safe social distances.
In fact, most business activity which thrives (or specializes) at distance has benefited while businesses which depend on one-on-one personal interactions have suffered. One on one interactions are traditional; distanced operations depend on technology to function, and that’s why we’ve focused on the technology sector today.
What we said about technology before
When Donald Trump became president in 2017, we took a quick overview at the economy, and we made a broad review overview of its sectors. Within the technology sector writeup, we identified two themes. First, automation: advances in robotics and machine learning have become a huge disruptive force for blue collar jobs in manufacturing, driving, retail sales, and customer service. Second, changes in skilled labor: Technology has always attacked the bottom of the skill tree first. More interesting, advances in AI have already started to augment, eliminate, or replace traditionally safer white-collar jobs like doctors, lawyers, and consultants. Finally, we’ve written elsewhere about the changes to the retail environment as the internet sales have replaced traditional brick-and-mortar sales.
In the aforementioned 2017 review, we were considering the disruptive impact technology advances were having on employment in the US. We didn’t expect the employment levels to necessarily retract, but rather we expect disruption where workers might have to find jobs due to the twin themes of automation and its expansion into skilled labor. For the past decade, the overall expansion of the US economy has been healthy enough to offset employment loses due to automation. Put another way, there will always be jobs of some sort available as long human beings have unlimited wants. That’s almost the very definition of economics: resource management within a world of limited resources and unlimited wants. If working age laborers have spare time, it can often be put to good use somewhere. However, automation changes the cost and benefits of different employment arrangements, so we expect disruption as to where those jobs are.
Let’s consider how the COVID crisis has accelerated the first trend we identified first, automation. Manufacturers already faced incentives (in terms of labor costs) towards limiting their number of human laborers necessary to produce goods. The government mandated limitations of workers in offices and factory floors (due to health concerns) created additional inducement to automate processes wherever possible. We’ve already seen major shifts in factory workflows as employers stretch their processes to reduce or remove human input wherever possible.
The second theme we identified was how the greater use of artificial intelligence and technological possibility might start to erode employment stability higher up in the skill tree. It has been too soon to say that the COVID crisis has measurably influenced this trend yet. If anything, the COVID crisis has instead put a premium on interpersonal contact, even remote contact, given how much of daily life has been involuntarily absorbed by automatic and technology driven solutions. Perhaps the greatest impact COVID has had on skilled labor employment (and how it intersects with technology) is in regard to the creative way it has been presented and provided of late. In the past six months, we’ve adjusted our goods consumption, replacing individual transactions with a distributed model with remote mail and shipping. Similarly, most skilled labor services can be presented virtually at a distance; there has been an explosion of use for online information sharing, network applications, and videoconferencing like Zoom, Hangouts, Skype, WebEx, and so on. Most skilled labor services do not require direct contact with clients or coworkers. There are exceptions including workplace-specific jobs (e.g. construction workers, electricians) and person-specific jobs (e.g. dentists, hairdressers) occupations, but a surprisingly large proportion of services can occur at a distance thanks to technology.
Finally, in our previous discussions of retail operations, we’d already noted online retailers like Amazon thrive and massive big-box stores (Wal-Mart) expand their online business. Conversely, the past few months have seen employment furloughs in small businesses coalesce into permanent layoffs as many small businesses contract beyond viability.
A more granular look
Some underlying industries within the technology sector were more directly impacted by the migration of life to the online and virtual equivalent. While the spring quarantine required this migration, this adjustment is likely to continue at an elevated rate for the foreseeable future. Some industries didn’t overtly benefit from the COVID crisis and online migration. For instance, there wasn’t a commensurate increase in telecommunication & electronics equipment (e.g. routers, WLANs) starting in March because the infrastructure for remote communication was basically already in place. On the other hand, we’ve already alluded to how IT services, given the focus on data processing and automation, were a beneficiary of previously identified themes. More directly, the underlying hardware which end users would need – semiconductor chips, mobile phones, servers, expansion cards, and other components – were substantial beneficiaries as individuals started expanding their digital activity. The underlying hardware for this change is in high demand. For example, a family might need more computers and components, like webcams, for remote learning.
Independently of the COVID crisis, there have been several tailwinds working for manufacturers in the technology sector. Manufacturing process breakthroughs at key provider AMD have spurred strong demand and competition from Intel. Microsoft and Sony are ramping up for the next home console cycle releasing this year. Technical innovation continues to expand the scope of where technology hardware can be usefully applied (e.g. Nvidia’s advances on autonomous machines).
The technology price pullback – this isn’t another dot.com bubble
The past few weeks have seen a modest pullback in the stock market, particularly centered on the technology sector. As investors, it is important to realize that this correction is a healthy reassessment of the worth of these companies relative to their stock prices. The recent pullback in technology stocks should not be interpreted to reflect a sector which has become dangerously unviable, as many technology companies were revealed to be during the 2000-era technology crash. In other words, technology company stocks have been running “hot” and valuations may have become stretched, but most companies within the sector have been thriving.
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