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Analysis & Learning

UK stock market decline

August 27, 2020

Years ago as a student at Oxford I read a book called ‘The strange death of Liberal England’, which was about the sudden fading of the erstwhile all-conquering Liberal party and its replacement by Labour. Something similar seems to be happening to the UK stock market, which seems to be going in the European direction of stagnant irrelevance.

I grew up with two especially vibrant stock markets, London and Wall Street. Nobody paid much attention to continental European stock markets, which were always a backwater. Other English-speaking stock markets could be fun, including Australia, South Africa, Canada, Hong Kong and New Zealand and that remains the case today. Every now and then these countries produce exciting growth stocks able to go head to head with the Americans but they are still relatively rare.

The puzzle is why London is dying a death. It is very marked what is happening. The FTSE 100 measures the performance of the 100 largest companies by market value quoted on the UK stock market. Between 1988 and December 1999, the FTSE 100 rose from 1,724 to 6,939, a rise of four times. Over the same period the Nasdaq 100 index, measuring the performance of 100 large Nasdaq-quoted shares but excluding financials, rose from 130 to 4,773, a rise of 36.7 times, which is a staggering performance.

Over 20 years later, where is the FTSE 100 now. It has been a bumpy ride since December 1999 with two ferocious bear markets triggered by the unwinding of the 2000 bubble and the financial crisis respectively and then in March we had the pandemic-inspired stock market crash. The latest level for the FTSE 100 is 6,105. It is significantly down on its 1999 peak. It finally staggered to a new peak of 7,904 in June 2018 but quickly fell back. 

The glory days for the London stock market are long gone. We haven’t had what I would call a genuine bull market for over two decades. It seems the 21st century is moving on without us.

What about the Nasdaq 100; how is that doing? On Wednesday it topped 10,000. At the peak around 10,150 it was 78 times higher than its level in 1989. By comparison, the FTSE 100 is up 3.5 times over that period. Amazingly, I still hear from investors who tell me they are only interested in UK shares. 

There are three reasons for this staggering difference in performance. They are technology, technology and technology. The US has a fabulous, constantly being replenished selection of great, world-beating, innovative technology companies bursting with energy, enterprise and ambition. The UK doesn’t.

This is why I keep repeating that a forward-looking equity portfolio should be built around a core of great US-quoted technology shares. Indeed, there is a respectable case for saying that it should only consist of such shares. I call these the ‘must-owns’ and they include all the usual suspects like Apple, Amazon, Alphabet, Adobe, Facebook, Microsoft, Netflix, Nvidia, PayPal, Visa and Tesla and many more, names like Advanced Micro Devices, Afterpay, Atlassian, Autodesk, Alteryx, Avalara, Bandwidth,, Broadcom, Cadence Design Systems, Carvana, Chewy, Chegg, Cintas, Cloudflare, Coupa Software, Crowdstrike, Datadog, Dexcom, Docusign, Epam Systems, Etsy, Five9, Hubspot, Intuit, Intuitive Surgical, MarketAxess, MercadoLibre, Monolithic Power Systems, MSCI, Nasdaq Inc., Paycom Software, Peloton Interactive, Pinduoduo, Ringcentral, Sea International, ServiceNow, Shopify, Splunk, The Trade Desk, Twilio, Veeva Systems,, Zebra Technologies, Zendesk, Zoominfo Technologies, Zoom Video Communications and more. 

Now take any other stock market in the world and try to make a similar list of fast-growing, disruptive, super innovative technology businesses. You can’t; you can’t come anywhere near. The US is not only so far in the lead it is out of sight but the lead is increasing all the time.

It is not just that the US is such a fertile breeding ground for these exciting businesses but that even if they are based elsewhere like Afterpay (Australia), Pinduoduo (China), MercadoLibre (South America), Sea Limited (South East Asia) and Shopify (Canada) their main quotes are in the US – actually Afterpay’s main quote is in Australia, like another exciting technology business, Xero but in other respects these companies are run exactly like the high growth US technology businesses with which they are competing. It is mostly American equity capital that is driving these success stories and there is a tidal wave of other exciting businesses able to raise seed and venture capital funding in the US on their way to a Nasdaq quote. 

The bottom line is that when it comes to growth share investing, the only kind worth doing in my opinion, the US has never been more exciting and much of the rest of the world has never been more boring and that, sadly, includes London. 

In that respect it seems we are true Europeans. The shareholder capitalism they distrust so much in Paris and Bonn but which always flourished in London and New York seems now to have found its true home in Wall Street.

The good news is that there is nothing to stop us buying these wonderful US shares and building our portfolios accordingly. My wife and I have portfolios, which are either 100pc US technology shares or where they are not, the other names are what I call US-style technology shares. 

There are UK shares which I like, Games Workshop, Halma, JD Sports, Liontrust Asset Management, London Stock Exchange, Polar Capital Technology Trust, Spirax-Sarco Engineering and Yougov to take some examples but they are mostly not frontline technology disruptors. We don’t seem to be able to make them in the UK any more despite our incredible history of producing some of the greatest engineers on the planet. 

It seems to be part of a whole different mindset. In America nobody expects Trump to solve the coronavirus crisis. This is not just because he is a waffling windbag but because the US mindset is to fix your own problems and not expect a handful of fallible individuals in government to do it all for you. 

In the UK many commentators seem to think that Boris Johnson is personally responsible for everything that goes wrong. It’s like a blame culture gone mad.

In America the corporate response to crises is amazing. They started by giving money and assistance in massive quantities to fight the virus.

Now companies across America are weighing in with money and concrete actions to help fight the ingrained racism that led to the brutal suffocation of a black guy for trying to pass a counterfeit $20 note. They don’t wait for government; they do it themselves. 

It is heartwarming to watch it in action and a side of America of which I suspect many people are unaware.

One effect of my enthusiasm for US technology shares is that increasingly I judge what is happening in stock markets by what is happening to the Nasdaq 100 and the technology shares I follow like those listed above. They can be extremely volatile as we saw last Thursday when US shares fell around six per cent in one day.

Whenever anything happens humans look for reasons. The reason put forward in this case is that Coronavirus case numbers in some states like Texas and California were rising. There were fears that the dreaded second spike was on its way and that economic recovery would be slower as a result.

This is all possible but a more balanced assessment was that nationwide new cases rose less than one per cent, the lowest figure since March. 

Furthermore European countries that have been emerging from lockdown have not seen great increases in case numbers. The US economy should still be on track for recovery even if continuing fears keep stock markets volatile.

I suspect that there are other more enduring reasons for share price volatility and investors should expect such volatility to be a continuing feature of stock markets going forward.

For many shares much of their value lies in expected future developments and these are by definition less certain and more vulnerable to changing expectations.

Few of the US shares listed earlier pay dividends. Their focus is on growth and they are spending heavily on sales and marketing and research and development to drive growth as fast as possible. 

This is exciting. Some of these companies are growing sales by 100pc or more annually. At that rate a small company becomes large very quickly and many of these companies are specifically looking to disrupt traditional ways of doing things and gain first mover advantage in the process. 

This means the bigger they grow the stronger they become until you end up with businesses like Apple, Alphabet, Amazon, Paypal and others which have gone from tiny to gigantic in 20 years. It is almost impossible to price such investments in the early years of their growth.

This makes them prone to incredible volatility. Between 2000 and June 2001 the Amazon share price fell from a peak $112 to $5.50. 

Bezos said afterwards that during this period the company carried on growing as fast if not faster than ever. It was all about sentiment towards a company, which was valued almost entirely based not on its current value and dividend paying ability but its opportunity to become a much bigger business in the future.

As we know even the biggest optimist underestimated the incredible growth that was coming and may still lie ahead for this extraordinary company.

As a result of this and other hyper growth stories investors are readier to believe that miracles can happen and pay up for the opportunity. In the short run this can make shares look almost insanely expensive as investors value loss-making businesses in tens of billions of dollars.

Add to that the huge influence in Wall Street of day traders and momentum investors. Then add to that the fact that nobody sells faster than a speculator seeing a profit rapidly disappearing and many of these high performing shares are showing huge paper profits for investors.

This is a potent cocktail to trigger periodic bouts of frenzied selling such as we saw on Thursday. Almost any trigger can set it off, which is why it so often seems to come out of the blue. 

I call these snakes and ladders markets. We climb the ladder and then we fall down a snake, again and again. 

The good news is that for well chosen shares the ladders are bigger than the snakes so overall excellent upwards progress is being made.

The implication for tactics is that most investors should tough out the snakes and treat them as further buying opportunities. This can be easier said than done because some of the snakes can be seriously scary and are invariably accompanied by exaggerated doom and gloom across the media.

The Nasdaq 100 index bottomed at around 1,000 in November 2008 and with wonderful round number symmetry peaked last Thursday at around 10,000. It has risen roughly 10-fold in 12 years. Over that period there have been roughly 10 periods of sharp profit-taking. 

None of them have lasted very long. The longest peak to trough was four months in the last quarter of 2018. The median period is around three months so it hasn’t required huge patience to sit it out until better times return.

The falls have sometimes been vertiginous. In the last quarter of 2018 the Nasdaq 100 fell 23.9pc in what was really another three month sell-off. The Covid-19 sell-off was even worse and even shorter. The index fell 31.6pc in less than two months and has already rallied to a new peak. I don’t think we are going to get another of these three month sell-offs for a while but who knows.

The effect on individual shares can be even more terrifying. While the Nasdaq 100 fell by around a third, shares in Afterpay, which were full of profit after rising from $2.62 to $40.89 in just under three years were hammered, falling by over 80pc from peak to the March trough. 

In response, the company put out a statement saying that its finances were fine and it was growing as fast as ever. The shares promptly recovered and within three months of hitting the lows they were again trading at a new all-time peak.

It is not for nothing that Warren Buffett says that buying shares in a publicly quoted company is like going into partnership with a manic depressive. The truth is that in the short run there can be an amazing disconnect between what the shares are doing and what is happening at the business. If you thought the business was great when you first invested it most probably still is even when the shares seem to be in freefall, especially if that is a result of macroeconomic developments outside the company’s control.

My view is absolutely. Their combined revenue is already approaching $1 trillion and they still have long runways of growth ahead given their key role in the world’s digital transformation. You could say that unlike Barclays and company these shares really are cheap.

What helps me is that I have seen some amazing bull markets in my lifetime so I know how mind-blowing they can be. In the 1960s Poseidon shares started at A$1. By the time they finished they were A$280.

I don’t think we are in a bull market like that yet but it could be coming. 

What is certain is that I have never seen so many companies growing as rapidly as I see now.

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