In recent years, investors have achieved higher returns with technology stocks than with “old economy” sectors such as transportation, energy, engineering, trade, finance or the general stock market. A number for illustration: over the five years from October 2015 to September 2020, the information technology stock sector produced a global return of 23.1% p.a. compared to 9.4% p.a. for the general global stock market (MSCI ACWI IMI Information Technology Index and MSCI ACWI IMI Index, nominal returns in euros each). Technology stocks also survived the corona crash in the first half of 2020 better than the rest of the market.
If a sub-segment of the stock market – e.g. If, for example, a country, an industry or an investment strategy delivers a high excess return relative to the overall market over several years, some private investors deduce from this that this excess return is “normal” and will continue in the future.
In this blog post we will show that the idea of the systematically (statistically sufficiently reliable) higher returns of the technology sector is an old fallacy that pops up every few years, like a zombie that doesn’t want to die. The zombie last wandered through the private investor community in the late 1990s. It temporarily disappeared when the dot-com bubble at that time began to burst in early 2000. Now he’s back.
The fact that investors could systematically take advantage of the supposedly higher returns on technology stocks was not true then, is not true now and will not be true in the long term either.
Before we get to some of the figures that illustrate our thesis, let’s first answer the question of why so many private investors are caught up in the technology stock mistake.
The most important of several causes is the so-called Recency bias – the all too human misconception of classifying data from the more recent past as fundamentally more important for the future than older data. With the high tech sector outperforming almost all other sectors in recent years, many investors believe that this is now “the new normal”.
The false conclusions favored by the recency bias are additionally reinforced by investment pornography spread by the financial media, i.e. publications that present unproven conclusions from a scientific point of view as something that is unquestionable or at least very likely – each mixed with the unspoken or explicit implication that private investors that could generate attractive additional returns. An example of this in financial pornography is the article heading “Technology stocks remain the only choice – they shone in the crisis and they continue to do so. Investors can bet on that” (GodmodeTrader finance portal, June 15, 2020).
It hardly needs to be emphasized that the financial sector is jumping into every fashion in its product marketing with which gullible investors can pull money out of their pockets. Of the more than a thousand equity ETFs sold in Germany, around a third replicate an industry or topic index. These ETFs have, on average, higher ongoing management fees than more broadly diversified, non-industry ETFs. The same applies to actively managed equity funds and to the more than one million certificates sold in Germany.
In investor thinking, the “built-in” recency bias, the financial pornographic headlines in the media, the fashion-driven marketing of the financial sector and investment pseudo-knowledge are interwoven into a subjectively round, coherent story for the investor: industries with strong technical progress and a higher proportion of young ” Disruptive “firms must inevitably be more profitable for investors than old-economy sectors with only slow technical progress and little growth. That is “the logic of digitization”.
As we shall see, this simple-minded story is only questioned when, a few years later, the degree of disappointment in the account statement has exceeded a notable intensity. At this point, however, there will already be a new “Investment Opportunity of the Decade” which, in our perception, appears just as logical and inevitable as the one with which the investor has just belly landed before. Now the game can begin again.
But now to some figures that make it clear that the technology sector does not produce any more attractive returns in the long term than the overall market and many ancient, low-tech industries.
We use US stock market data for this statistical exercise because it has the highest data quality and granularity for time periods far back in the past and because it is publicly available to everyone on the website of the American economics professor Ken French. US data in this case should be representative of the rest of the world as our focus is on comparing industries relative to each other.
The following table contrasts the returns of the high tech sector with other industries over the past 50 years. “High Tech” is the designation in the underlying database for what is typically called technology stocks in industry jargon. The underlying industry classification divides the entire US stock market into ten main sectors. Four of the five FAANG shares (Facebook, Apple, Netflix and Google, but not Amazon) also belong to the high tech sector. We benchmark this sector with the overall market as well as with 49 other, more granularly subdivided industries, which together form the overall market.
Table: Comparison of returns of the US high tech (HT) equity sector with the overall market and other industries for the period 07-1970 to 06-2020 (50 years) – inflation-adjusted (real) returns in USD, before costs and taxes
Return high tech sector (HT)
Total market return
Yield rank high tech sector within 10 major sectors
Return of the best
07-2015 to 06-2020 (5 years)
1 of 10
20.6% p.a. [B]
07-1970 to 06-2020 (50 years)
5 out of 10
The first 25 years
10 of 10
The second 25 years
3 of 10
Worst HT sector decade [A]
10 of 10
► [A] The decade from 07/2000 to 06/2010. For this evaluation, the 50-year period was divided into five non-overlapping decades. ► [B] Microchip manufacturing is one of four industries in the 49 industry segmentation that make up the “high tech” sector in the 10th classification. ► Telecommunications are not part of the high tech sector here. However, including TK would not significantly change the numerical results in the table. The “notorious fall” of the Telekom share in Germany is likely to be atypical for the return on shares in the TK sector worldwide. ► Overall market = CRSP 1-10 index. ► Data source: Ken French Data Library.
What are the main conclusions that can be drawn from the numbers in the table?
(a) Yes, for the past five (or seven or ten) years, technology stocks have beaten the general stock market in the US (and around the world).
(b) Over the total period of 50 years, the high tech sector produced a return almost exactly that of the general stock market. However, the HT sector exhibited a significantly higher risk than the overall market, namely one and a half times as high volatility (fluctuation in return) and a maximum cumulative loss (maximum drawdown) of minus 81% in September 2002 compared to minus 55% for the overall market in September 1974 (both values adjusted for inflation). “Risk-adjusted” high tech was therefore worse than the market as a whole for 50 years. The best shareholder return of the 49 industries was in arms manufacturing, and the second highest in tobacco.
(c) If you divide the 50 years in half, high tech was noticeably worse than the overall market in the first half and better in the second half. But even in these second 25 years, HT only crossed the finish line in the top return range of 49 industries and was almost overtaken by the “old” shipbuilding industry on the 25-year “middle distance”.
(d) If you look at the worst decade for HT among the five non-overlapping 10-year periods in the 50 years under consideration, HT is again not from the winning side: 9.6% average loss per year from July 2000 to June 2010 versus only 3.1% loss per year for the overall market. The HT share performance appears even more meager this decade relative to the high 10-year return of the “Stone Age sector” coal mining. It should be noted here that this weak decade for HT stocks was not long ago.
Interim conclusion: If you include a longer period of time in a data analysis, instead of just selectively the last few years, then a “slightly different” overall picture emerges than what technology stock fans like to convey.
Occasionally it is claimed that there has recently been a kind of structural break in the stock market, which is why data that have lasted longer than z. B. ten years ago, are no longer relevant in terms of technology stocks. This argument, never really proven, seems funny and naive. This is already clear from the fact that the buzzwords, concepts and technologies that are used today to explain the high returns in the high-tech sector in recent times – internet, digitization, network effects, artificial intelligence, scaling and so on – all do existed 20 or 30 years ago. Konrad Zuse built the first computer in 1936.
The question “what’s really new?” indirectly leads us to an explanation of why HT stocks have historically simply performed average and why this will probably also be the case in the future. To see and understand this real explanation, however, requires two things:
- In terms of empirical data, one has to go to the trouble of looking behind the selectively selected short-term data from the past few years and behind the history of individual stocks that the financial industry and the media commonly spread.
- With regard to the logic of the subject, you have to stick to the old lady science and not to beautiful simple-sounding stories and gut feeling economics.
From the point of view of science, some important factual facts on this topic look like this:
In empirical financial market research over the past 60 years or so, sectors have not been identified as systematic drivers of return and risk in stocks. The only systematic drivers of risk and return are the so-called factor premiums (see our blog post Factor Investing – the Basics from May 2019). Understanding this is of course less exciting than the colorful stories about the latest industry trends, sensational product innovations in consumer electronics and famous technology celebrities such as Steve Jobs or Elon Musk (see our blog post The best share in the world from June 2020).
Of course, the sector a share belongs to has an impact on its return. That is trivial. A mere influence does not help investors, however, if this influence is not of a systematic nature, ie it is not “exploitable” in the future. Of course, companies in the information technology sector have better growth prospects than most other sectors. That is also trivial.
However, these better growth prospects are already factored in at any given point in time, because the entire market knows them and then simply assumes them for the future. Looking forward, you will therefore no longer have a systematically exploitable yield advantage for the stocks in question. One indicator of this pricing is the high valuations of technology stocks today. For example, the price / earnings ratio of the five FAANG shares at the end of September 2020 was around 61 (simple average). That is around three times as high as the P / E ratio of the overall market. Essentially, this means that the market expects business figures to be three times as good (in total) for the five companies in the future as for the market as a whole, so that only the same return on shares as that of the market as a whole results.
In order to produce higher shareholder returns than the market as a whole in the future – as FAANG investors expect – the profits of the five companies must grow faster than three times as much as those of the market. Three times as much is already priced in.
If this extreme growth does not come in the future, in our opinion nobody should be surprised, because it has already happened in the past. A multi-year underperformance in the technology sector is not unusual, as our table shows.
Since we all love stories, finally the story of the “race for returns” between Walmart and Intel. Walmart is a boring supermarket retailer, albeit the largest in the world by sales. In supermarket retail, the margins are known to be razor thin and technical progress is rather slow. Intel is the world’s largest microchip manufacturer, a global technology leader that owns 40,000 patents and has high margins.
The publicly available share price data from Intel goes back a good 40 years to February 1980, the data series available for Walmart is longer. In the 40.6 years to September 2020, the old economy share Walmart generated an impressive return of 20.7% p.a. versus “only” 14.6% p.a. for Intel (nominally in US dollars including dividends, before costs and taxes). Walmart has also been ahead for the past five years and the past 20 years.
– Conclusion –
The opening question to this blog post was “Do technology stocks keep higher returns?” As we have now seen, this has not historically been the case. In order to recognize this banality, however, one must not Data snooping operate, i.e. selectively only select short periods of time and ignore other evidence that does not support your own thesis.
Regardless of whether the world stock market is broken down into ten, 49 or 100 industries, there are always periods of five or more years in which individual industries significantly outperform the overall market and individual industries for which the opposite is the case. The more you unravel, the greater the differences between the industries become apparent. It had nothing to do with high tech versus low tech.
Can you reliably identify these inevitable phases of outperformance in individual industries in advance? No. Even the few real investment superstars still around today – above all Warren Buffett – don’t claim that; neither is science.
Anyone who, from the point of view of this science, strives for a sensible risk-return combination for their assets is badly advised to take the route Sector picking to try. It is smarter to have all industries in your portfolio.
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