Market review

Global equity markets pulled back in November, but sterling-based returns were flattered by weaker sterling, with the MSCI All Country World increasing 0.6%. The S&P 500 held up better, increasing 2.4%, while the DJ Euro Stoxx 600 fell -1.6% (all returns in sterling terms). Investors faced macroeconomic crosswinds from inflationary data, more hawkish central bank commentary and renewed COVID-19 lockdowns in Europe before a risk-off mindset permeated global markets when expectations were upended by the emergence of the highly mutated Omicron COVID-19 variant at month end.

In the US, the October employment report was stronger than expected, with non-farm payrolls +531,000, well above forecasts at +450,000. The previous two months were also revised up sharply, suggesting the economy has been rebounding rapidly from the Delta wave, and the unemployment rate declined from 4.8% to 4.6%. However, the ‘Great Resignation’ continued, with the labour force rising by a muted +104,000, and the labour force participation rate remained at 61.6%, significantly below pre-pandemic levels. Average hourly earnings rose +0.4% m/m and +4.9% y/y, confirming there has been little pick-up in labour supply. That said, JOLTs’ job openings are coming down slowly from an August peak. The Flash PMIs for November showed although there are tentative signs that supply shortages are easing slightly, labour and product shortages are still weighing on recoveries in advanced economies.

Commodity markets pulled back towards the end of the month, which may help relieve inflationary pressures over the coming months.

In the US, PPI remained at +8.6% y/y in October, matching the largest increase on record, while the CPI came in hotter than expected at +6.2% y/y, with inflation broadening across components. With inflation running above wage growth, the University of Michigan Consumer Sentiment Index fell from 71.7 to 66.8 in November (below forecasts at 72.5), the lowest since November 2011.

Commodity markets pulled back towards the end of the month, which may help relieve inflationary pressures over the coming months. Brent Crude fell -16.1% driven by dollar strength, news that the US and other major economies intend to release barrels from the strategic reserves, and finally the Omicron variant.

The FOMC initially announced plans to taper asset purchases by $15bn in November and December, as widely expected, but did not commit beyond that. At that pace, the purchases would have ceased entirely by June 2022. Later in the month, the Fed minutes revealed that some FOMC participants were pushing for faster tapering of monthly asset purchases due to fears that high inflation would prove to be more persistent than previously believed and leading to the potential for inflation expectations to become unanchored. Having insisted that the surge in inflation was "largely" transitory earlier in the month, after the release of October data Fed Chair Jerome Powell acknowledged the “risk of higher inflation has increased.”

Simultaneously in Washington, President Biden announced he will nominate Powell for a second term as Fed Chair. The other front-running candidate, Lael Brainard, was nominated as Vice Chair. This largely matched market expectations and tempered fears over greater banking regulation, which Brainard is known to favour. After weeks of negotiation, the House approved the long-stalled $1.2trn infrastructure package. This bill includes more than $500bn in new spending over the next eight years that will be invested in "core" infrastructure projects in transportation, broadband internet and utilities. The White House has billed the measure as a "once-in-a-generation investment" and has projected that it will create two million new jobs.

Rate-hike expectations were somewhat tempered at month end by the emergence of the Omicron COVID-19 variant. Much uncertainty remains around the new variant, as clinical data is not complete enough to draw conclusions on the transmissibility or severity of the virus, or the efficacy of existing vaccines yet. The US 10-year yields fell to 1.44% due to increased uncertainty over the likely impact on the global recovery. Lower rates saw large-cap growth stocks outperform value – the Russell 1000 Growth Index gained 0.5%, while the Russell 1000 Value Index fell -3.7%. Mega-cap ‘safe-haven’ technology names like Apple, Amazon and Meta significantly outperformed while the small-cap Russell 2000 declined -4.2%.

Technology review

The technology sector made further gains in November as the Dow Jones World Technology Index increased +5.1% in sterling terms. However, index performance once again disguised vastly differing fortunes of the major subsectors within technology. The SOX Semiconductor Index jumped +11.2%, while the NASDAQ Internet Index and Bloomberg Americas Software Index both suffered significant losses at -8% and -3%, respectively.

The off-quarter reporting companies largely continued the trend of a volatile earnings season established during Q3 reporting. The main culprit remained guidance that was more cautious than anticipated. In payments, PayPal produced a disappointing quarterly report as revenues were softer than already lowered expectations on weaker than expected back-to-school and travel spending. The faster than forecast eBay transition also continued to be a greater headwind than expected. The disappointment was compounded by guidance that came in below consensus for both Q4 and 2022. The initial guidance commentary of high-teens revenue growth in 2022 versus expectations for low 20s was badly received with supply-chain shortages, a tough comparable on stimulus payments and more in-store shopping cited as reasons for the caution by management. The Venmo/Amazon partnership was an unexpected positive and should help drive awareness/adoption of Pay with Venmo and improve monetisation. Management reiterated the five-year organic guide for TPV +25%, Rev +20% and EPS +22% and expect to exit 2022 growing faster than this.

The continuation of tailwinds in this area is supported by several hyperscale customers recently sharing robust capital spending forecasts for 2022...

In semiconductors, NVIDIA produced an impressive earnings report with Gaming growing +42% y/y and Data Center growing +55% y/y. Data Center performance was the standout once again as the scale-out of natural language processing led to the doubling of hyperscale compute revenues from a year ago. The continuation of tailwinds in this area is supported by several hyperscale customers recently sharing robust capital spending forecasts for 2022, particularly in AI/ML. Next-quarter guidance was ahead of expectations and leaves NVIDIA on track to deliver full-year revenue growth of +60% y/y. With NVIDIA’s Omniverse offerings successfully exiting beta trials this year (said to expand its TAM by $100bn), it remains exposed to many highly attractive end markets.

Roblox disproved fears over tough pandemic comps and back-to-school headwinds by delivering an impressive earnings report and commentary. The Q3 bookings and EBITDA were in line with consensus, but importantly October bookings were strong despite the impact from the 70-hour platform-wide outage at the end of October. Excluding the outage, the month-on-month booking growth in October was an implied +10%. Average DAUs of 47.3 million in Q3 was up +31% y/y, with October experiencing an average DAU level of 50.5 million prior to the outage. The positive news flow continued throughout the month as Roblox’s investor day highlighted their early leadership in the metaverse.

Another quarter of sequential acceleration in subscription revenue was particularly noteworthy.

In software, Workday delivered a solid quarter. Subscription revenue, a 24-month subscription revenue backlog and operating margins all beat guidance and consensus expectations, albeit by a smaller magnitude than recent quarters. Another quarter of sequential acceleration in subscription revenue was particularly noteworthy. Initial annual guidance for subscription revenue growth of 20% was below expectations but is likely conservative, especially when taken in the context of upbeat management commentary on broad-based strength and record pipeline generation.

Software stocks’ reporting in early December also offered generally robust outlooks, albeit against heightened expectations. However, disappointing stock reactions triggered a long-overdue selloff for the highest growth stocks. That said, Elastic was a disappointment failing to deliver heightened expectations of an inflection in SaaS Cloud revenues this quarter. Despite this, SaaS revenues of $69m were up +84% y/y and increased to 34% of total revenue, versus 32% last quarter. Total revenue of $206m was ahead of consensus and grew +41% in constant currency. Billings growth of +29% y/y marked a modest deceleration from the previous quarter, which weighed on the stock, while large customer net adds (defined as those with average contract values over $100k) were strong with a record number of net adds achieved during the quarter to reach 830.

Okta, however, confounded critics and delivered strong results with a beat across all major metrics. Notably, organic growth accelerated to +40% y/y versus +39% last quarter and +37% the quarter before.Next quarter guidance comes in above expectations but implies a slowdown in the core business to low/mid-30s. The preliminary FY23 revenue guidance of $1,750m at mid-point represents growth of +37% y/y and to us looks conservative given the expected contribution from its Auth0 acquisition. Management reiterated its forecast of growth of at least 35% each year to a FY26 target of $4bn with 20% FCF margin.

Snowflake continued its run of exceptional earnings prints as product revenue growth accelerated to +110% y/y. A key growth driver in the quarter came from its largest customers as management noted five of its top 10 customers more than doubled their product revenue spend on a year-on-year basis. Non-GAAP operating margins crossed into positive territory for the first time, while forward guidance came in at over 10% above consensus – a bigger raise than usual.

Outlook

The NASDAQ remains close to all-time highs and the ratio between the NASDAQ 100 and the Dow Jones Industrial Average exceeded its 2000 peak at the end of the month, but this belies a breakdown in index breadth and elevated volatility below the surface. Fully two-thirds of NASDAQ stocks are in a bear market, while more than one third have at least halved from their all-time highs. The software index (IGV) lagged by more than 10% during the month.

Declining breadth is not limited to the tech sector, with only 43% of S&P 500 Index stocks closing above their 200-day moving averages at the end of the month, down from more than 80% in June. During the month, the VIX rebounded back above 25, and the US Treasury 10-year yield whipsawed between 1.44% and 1.67%. This narrowing breadth, and the market volatility that has accompanied it, reflect a heightened level of uncertainty around the Omicron variant, the inflation outlook and the Fed’s response to it.

Powell’s re-election and subsequent recharacterization of inflation as no longer “transitory” has increased the perceived likelihood of accelerated tapering and rate rises in the near term and is in line with more hawkish FOMC minutes and committee member commentary. A sharp selloff in short-dated rates caused the yield curve to compress to a level last seen in March 2020, and as rate hike expectations are pulled forward, the long end of the curve continues to come down as expectations of further out rate hikes diminish. The heavily mutated spike protein present in the Omicron variant could reduce current vaccine efficacy (as the Moderna CEO expects) but should still hopefully be effective in preventing hospitalisations, according to the BioNTech and Pfizer CEOs. In any case, the risks of a policy error, a growth shock and even a benign shift to a more transmissible but less fatal dominant COVID-19 variant have brought a wide range of outcomes into play.

Against the backdrop of heightened macroeconomic uncertainty and market volatility, we remain positioned in a balanced way across sectors and well diversified across stocks.

Pockets of market exuberance still exist, but encouragingly we are now starting to see a healthy correction in many extended areas and stocks. The IPO market has remained very hot, with the number of US IPOs reaching levels not seen since the late 1990s. SPACs (about 60% of the total by number and value – we have participated in none) have been particularly weak, with only c10% trading higher three months after reporting their initial public quarters. More concerningly, Dealogic data shows half the largest IPOs (raising >$1bn) this year in London, Hong Kong, India and New York are now trading below issuance price, up from 33% in 2019 and 27% last year. We have chosen to avoid most of these deals but will pore over the better ones once valuations are closer to levels with more valuation support.

Against the backdrop of heightened macroeconomic uncertainty and market volatility, we remain positioned in a balanced way across sectors and well diversified across stocks. The most recent earnings season has seen stocks sell off hard on any perceived blemishes and positive reactions to only the strongest of prints.

Investors have continued to crowd into large, liquid, US-based names: the Russell 1000 Technology Index (large cap) returned +3% during the month while the Russell 2000 Technology Index (small cap) returned -3.2%, continuing a trend that has seen large cap (+33.6%) outperform small cap (+11.6%) significantly year to date. This remains a significant headwind to our style, given we are structurally underweight mega-cap companies, even if many represent large absolute positions for us.

At the time of writing, we are in the middle of a selloff in software companies and other growth stocks. At month end, software forward EV/sales multiples had compressed c20% across various size and growth cohorts. This has impacted some of the highest growth/highest multiple companies but is beginning to present more interesting opportunities, especially for companies able to pass through upward pricing pressure from components and wages. For now, our more conservative positioning looks appropriate: more balanced between secular and cyclical growth, a little cash, and a slither of NASDAQ (NDX) put options designed to ameliorate the extra beta that comes with a growth-centric investment style in the event of a meaningful setback.

As long as Omicron or policy error does not materially change the economic outlook, we expect to take advantage of some of these buying opportunities...

However, this near-term caution should not be confused with a lack of conviction in the Trust or the outlook for the technology sector. Rather, we believe our sector will remain buttressed by powerful secular tailwinds while the fundamentals for most of our stocks remain robust. With our large team we have attended (mostly virtually) an extensive number of company meetings, conferences and presentations recently. The tone from these interactions has been generally very upbeat, with strong demand and reasonable expectations for 2022, which look eminently achievable to us. While the current correction may have further to run, many good companies have retraced 20-30% from their recent stock price peaks. As long as Omicron or policy error does not materially change the economic outlook, we expect to take advantage of some of these buying opportunities, while recent weakness that, for now, remains largely divorced from fundamentals makes us feel more upbeat about the prospects for technology stocks in 2022.

As at  08 December 2021