Mega-Cap Tech a Safe Haven

What investors Want

For investors old enough to remember the late 1990s, the idea of tech as a haven during periods of market volatility seems odd. These were the stocks that led the market bubble on the way up and were punished the most when the bubble finally burst in 2000. What has changed? The simple answer is the companies in this sector are more mature, less volatile, and more profitable.

One important reason that large-cap technology stocks have held up, despite the surge higher in interest rates: these companies generate strong cash flow. Contrast this with their younger, early-growth cousins. Early growth companies are down roughly 30% from the July peak. The backup in interest rates has been particularly punishing for these companies because their cash-flow is in the distant future. Put differently, a higher discount rate has a more negative impact on early growth companies than those with significant near-term cash flow.

The fact that these companies are more mature and more profitable, also means that, unlike the 1990’s, many of the mega-cap tech companies trade close to a beta of one. In other words, they generally trade with no more volatility than the broader market. This is important because in the current environment investors are demonstrating a clear preference for lower beta companies and an aversion to excess volatility.

The other distinguishing characteristic of these companies: Not only are they highly profitable, but their profits are remarkably consistent. The large, ‘platform’ companies have strong entrenched user bases and consistent demand. And with interest rates high and the economy likely to slow from here, consistency is becoming more important to investors.

Large Cap Tech = High Quality

Tech outperformance looks less strange viewed through a factor perspective. While the market can rally into year-end, investors are likely to prove more risk averse than they were earlier in the year. Higher rates, tighter financial conditions and the prospect for an economic slowdown have left investors with a clear preference for safety and an aversion to volatility. Our view is that mega-cap tech names offer these quality characteristics. They are highly profitable and, perhaps somewhat surprisingly, reliable.

Russ Koesterich, CFA, is a Portfolio Manager for BlackRock's Global Allocation Fund and Lead Portfolio Manager for BlackRock’s Global Allocation (GA) Selects Model Portfolios and is a regular contributor to Market Insights.

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