There’s a big difference between the TSX Composite Index and the NASDAQ. That difference was highlighted this week by the comparative performance of these two indices. But there’s also a big difference between the types of tech stocks that characterize that segment of the TSX and the kinds of tech stocks that appeal to NASDAQ investors.
Hot vs. boring tech stocks
There are two broad categories of tech stocks: speculative plays and reliable businesses. The divide occurs at the hot/boring boundary. High momentum tends to favour the hot end of the spectrum, though this is not always the case. This year saw relatively dull businesses exhibit a huge amount of momentum, as the quarantine highlighted the need for a remote workforce and digitalized work places.
The problem with this digitalization process is that, while it is likely to extend beyond the pandemic, its momentum in the markets might not. Names such as Kinaxis and Shopify have already been pulling back, as the economy slowly reopens and the prospect of a working vaccine comes closer to reality. While such names are undoubtedly worth owning, buying at inflated prices may be a misstep at this time.
There’s the hot/dull boundary to consider. Relatedly, this intersects with another boundary between a quarantined society and a post-pandemic return to something resembling normal life. The pandemic/recovery threshold splits tech stocks in a very similar way to the hot/boring boundary. The take-home message is the same, though: what’s hot during the pandemic will cease to be so after a recovery.
There’s another element that complicates matters. This is the concept of the undiscerning tech investor. Some momentum investors will buy tech stocks simply because they’re tech stocks. The problem with this approach is that it ignores all the subdivisions and interconnected industries within the tech sector. This is why consumer discretionaries like Apple get lumped in with supply chain names like Kinaxis.
Wait for a market correction to buy
The pandemic has bred its own hybrid version of momentum investing. The influences were there before the public health crisis, though. Look at the rise of zero-commission trading, which emphasizes high-risk plays catering to less-experienced investors. Look at the pre-existing boom in e-commerce, exemplified by the rise of Shopify. Then along came the pandemic and its attendant panic over quick income.
Since these trends were already in place before the pandemic, this new type of momentum investing is likely to outlast the health crisis. However, an economic recovery should, in theory, relieve some of the pressure on investors to take on more risk than they should. Boring tech stocks will go back to being boring, hot tech stocks will see a correction, while those trillion-dollar names go back to slow and steady share price appreciation.
In short, investors should think about waiting it out. Overvalued names should be trimmed from a portfolio, while a coming market correction will bring opportunities to buy back in at reasonable entry points.
