Legendary British investor Terry Smith: Tech companies should return when money is no longer ‘free’

  In 2022, unless most of your stock investment (US stocks) is concentrated in energy companies, you will definitely experience a retracement of your net worth. The reason for this is that we are exiting a long period of monetary easing: a period of government spending far exceeding revenue and macro-low interest rates.
  Monetary easing can be traced back to the Greenspan era. In the 1990s, we encountered many crises, such as the Asian crisis in 1997, the Russian financial crisis in 1998, and the collapse of Long-Term Capital Management in the United States. During these market volatility, low interest rates are used as a pain-relieving measure.
  With the dawn of the new millennium came new crises, and those crises required more money.
  It started with the bursting of the dot-com bubble in 2000, followed by the credit crunch of 2008-2009. These increasingly serious risk events require the central bank to release more extreme water in terms of fiscal policy and interest rates. Quantitative easing (QE) started with government debt but eventually expanded to include corporate debt and stocks.
  One of the problems with lowering the cost of capital is that it leads to wrong capital allocation or investment decisions whose problems are exposed when the tide goes out.
  We saw this in Japan in the late 1980s, when during the bull market the estimated value of Tokyo’s Imperial Palace gardens at one point exceeded the entire state of California; the Tokyo Stock Exchange traded at around 100 earnings. “Zombie companies” that should have closed down were supported. At that time, we thought that these were unique macro characteristics of Japan. The subsequent Internet bubble and the global financial crisis have proved that Japan is not the only country that will experience mania, and that “liquidity carnival” may start in every corner of the world. During the dot-com bubble, money would even pay for a fledgling idea, and the resulting crash would be widespread.
  The 2008 credit crisis started from the US real estate market and quickly evolved into a full-scale international banking crisis.
Tech stocks, long-term bonds experience pain as rates rise

  Another problem with easy monetary policy is that it always has an end.
  When the global epidemic crisis occurred in 2020, the central bank decided that they should double down on their new toy – QE, which was very effective in the credit crisis and had no obvious side effects.
  It’s just that the central bank has overlooked a problem. Before QE was effective, it was because there was no problem with demand or the banking system. However, the epidemic has caused people to be locked at home, unable to shop, travel and entertain in physical stores, and global supply chains have also been suspended. Consumers have accumulated savings but cannot consume.
  What happened next is probably a case of Murphy’s Law, Finager’s corollary “prophecy”: if something can go wrong, it will.
  Under the Finager law, the conflict between Russia and Ukraine in February 2022 affected the prices of commodities such as oil, natural gas and other minerals, such as nickel, as well as grain. The result of monetary easing and the ongoing conflict between Russia and Ukraine was a surge in inflation, and the significantly high inflation forced the Fed to quickly and painfully end the loose monetary policy.
  When interest rates rise, bonds with longer maturities fall more than bonds with shorter maturities. The same is true for stocks, with higher-rated stocks and tech stocks suffering more from downturns than lower-rated or value stocks. The five worst-performing stocks in our fund follow this pattern.
  Four of the five stocks are in the broad tech sector (although Meta is actually in the MSCI Communication Services sector, which lists Amazon as a consumer stock), and at least two—PayPal and IDEXX—are in the broad tech sector. At the beginning of the period, its valuation was particularly vulnerable to rising interest rates.
  When technology companies themselves have some problems, the decline in stock prices becomes more obvious. Meta’s problems with regulatory and competition bodies have been widely publicized, and significant funding has been announced for the development of the so-called Metaverse.
  PayPal (PayPal), which already has a leading position in online payments, has fared poorly, but its stock price has not fared much better. The reason may be that there is no control over costs and neglect to expand to new customers during the epidemic. Also, PayPal has acquired some overpriced companies in the past, so the share price drop isn’t a surprise. That’s what happens when management decides that an investment doesn’t need to earn an adequate return.
Tech companies should stop dead projects and return to core business
The 5 Worst Performing Stocks Among Scheduled Funds

Data source: State Street Corporation

  No company is immune to falling valuations due to rising interest rates. However, looking back at Amazon’s performance after the dot-com bubble burst, investors who own stocks with good fundamentals will at least win the rebound later when the stock price falls. Investors who are “Big Fools” who hold stocks with no cash flow, profits, or even income, have suffered heavy losses.
  And outside of macro factors, tech stocks are facing some fundamental headwinds. During the period of home office, digitalization was promoted and applied on a large scale. When normal office work gradually resumed, the growth rate of digitalization slowed down.
  In addition, as the economy slows down or even declines, B-end and C-end spending on digitalization is decreasing, and the consumption cycle of online advertising has also entered a downward phase.
  Of course, there may be a silver lining in this “cloudy sky.” Constrained by the pressure of performance growth, some technology companies may start to pay attention to the efficiency of the use of funds, stop thinking that funds seem to be free, and stop some less promising projects.
  Example: Alphabet: Its “other investments” with huge losses. It should get back to the core, which is a good online search and advertising business.
  Amazon: It appears to have exited food delivery and tech education in India. It has a very successful e-commerce and cloud computing business, which it can focus on.
  Meta: Can it stop or reduce spending on the Metaverse? Without these spends, we would have a leading communications and digital advertising business. Its P/E ratio is in the single digits.
  We continue to use a simple three-step investment strategy: buy good companies;
  don’t overpay; and
  do nothing.
  If you own stocks of companies during inflationary times, it’s best to own companies that have high returns and high gross margins. This year, I will conclude with a quote from Winston Churchill: “If you are going through hell, keep going”. At Fundsmith, we intend to do just that.

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