Shorting technology and high growth stocks is the new way for markets to play rising rates) or to be more specific expectations of rising rates). Until now, markets have spared GARP (Growth at Reasonable Price) stocks and focused on GAAP (Growth at Any Price). The selling has been wide-spread and indiscriminating. The largest injuries have been inflicted in so-called “loss-making” companies.

The long reasoning for selling (or shorting) high growth names is that higher rates are mathematically depressing the present value of future cash flows. The short rationale is that as the liquidity tap is being closed, investors are going risk-off. “Loss making” companies are considered risky and therefore they are the first one to be dumped. There is another risk that the market is less willing to bear: the risk of having the wrong names in a very discriminating environment. The unicorns are not all born equal: how many eBay, Netscape and other are needed to get an Amazon.

For most market investors, the real risk of inflation and high rates is a new experiment. The reversal trade from what the market experienced between September 2020 and February 2021 is a very significant and so is the damage caused to some very interesting long-term stories.

Within technology, we would split the universe in three groups:

The first group is hardware technology: companies that manufacture semiconductors or semiconductor manufacturing equipment and other components used in PC, cell phones, data centres and telecom infrastructure. Examples are TSMC, AMAT or Murata. These companies trade on “normal” PEs and have tended to outperform the market in 2021.

The second group is made of established software and fabless. Little manufacturing is involved, assets are mostly software and intellectual properties. When needed manufacturing is outsourced. This group include Google, Metaverse, Microsoft, Salesforce, NVDIA, AMD, Apple. In terms of performance, the mega caps have tended to outperform the Index, whilst the second-tier large players such as Adobe or Salesforce have performed in line and at times below the index.

The third group is made of high growth, high potential, disruptive companies at an earlier stage of their corporate life. Most of them are constantly re-investing their cash in growth and therefore registering accounting losses. This group led the 2020 year-end rally, performed well until mid-February 2021, peaked out and from there were trashed. The market has sold them despite on-going strength in fundamental. Various narratives are at play behind the selling: correction from over-extended levels reached earlier, switch from growth to value, slowing growth momentum.

More than ever, we think that at current levels, investing selectively in data centric stocks will warrant attractive long-term returns. The long-term story is unchanged. Rising rates is causing markets to question valuation of stocks. Not finding easy answers on high growth high valuation names, the first obvious move is to dump them.

Valuation can fluctuate in the short-term but does not matter in the long term that is decided by the intrinsic growth potential of an investment.

In the words of a great investor and writer, Howard Marks from Oaktree: “Everyone wishes they’d bought Amazon at $5 on the first day of 1998, since it’s now up 660x at $3,304”. 

• But who would have continued to hold when the stock hit $85 in 1999 – up 17x in less than two years? 
• Who among those who held on would have been able to avoid panicking in 2001, as the price fell 93%, to $6? 
• And who wouldn’t have sold by late 2015 when it hit $600 – up 100x from the 2001 low? Yet anyone who sold at $600 captured only the first 18% of the overall rise from that low.

We are highly confident in each of our holdings. Rising inflation and interest rates have been in the pipeline. We don’t believe that they affect high growth stocks in the long term. We believe the best rules to cross adverse market conditions are

1-      To stick to our long-term convictions with a focus on quality

2-      Diversification in terms of valuation with a high exposure to GARP stocks and significant exposure to cheaper names with strong catalysts for a re-rating?

The decline is and has been severe during the previous months. Meanwhile, companies continue to generate sales and cash-flow. We should differentiate market perception and fundamentals as shown in the following chart, representing the price evolution of the current portfolio with sales and their perspectives: