Last year tech stocks reached all-time record highs, but 2018 is off to a shaky start with the tech sector selling off almost three per cent. Vitali Mossounov, Vice President, TD Asset Management, shares his take on regulation, the media reports surrounding Apple and Intel, along with his broader outlook on the tech sector.
Last year the technology sector was a stock-market darling, with some stocks posting triple-digit gains for the year. But 2018 is off to a shaky start. So, is tech still a stock-market darling or have things taken a turn? Joining us to explain is Vitali Mossounov from TD Asset Management. Thanks for being here.
Good to be here.
So I have to start off by asking you, we've heard lots of headlines around tech. In terms of the themes that are happening right now, what's notable and what's noise?
Let's put things into perspective first. For sure, 2017 was a phenomenal year for tech. The stocks did really well and outperformed the market by a wide margin. But tech hasn't been a slouch in 2018 either. Looking south of the border, at the US, tech is the best-performing sector year to date, 5% better than the S&P 500. Here in Canada, tech is also the best-performing sector and actually by a country mile. So I would avoid the negative headlines. Tech investors are doing pretty well this year.
Of course, with the market flat for the year and volatility way beyond what we've seen really in 2017, it's easy to paint a negative narrative around tech. We're also hearing headlines and noise around regulation and other themes. And so I would be very cautious about taking those, analyzing them, but then putting in them in real context about whether they matter and what the actual returns are.
You mentioned regulation, which I want to ask you about. As an investor, how could that potentially unfold?
We think there's going to be a lot of pressure, a lot of news flow through the year. So looking at this geographically, in the United States, midterm elections are coming up in the fall. And given what transpired in November 2016, every internet company of size, they're going to be under the microscope.
Now in Europe, politicians, they don't only have bark, they have bite as well. Just weeks ago, we saw a new digital interim tax rolled out by the authorities there. And that might have some impact on the internet companies. And then in late May, we're going to get something called GDPR, basically new privacy regulations out of the EU. That might also have another impact.
Finally, don't discount the traditional media. Remember, the internet companies have been really eating their lunch for over a decade. And now the old guard smells blood. And they're going to do everything in their power to try and convince citizens and politicians that something needs to be done to curb the power of the internet conglomerates.
Something you mentioned there-- and I know we're probably still early days-- is the impact of consumer behavior. How do you see consumers responding?
That's really the million dollar question there. Because regulation, while it's an important matter, it's relatively minor in the context of the events that are unfolding today. Put very simply, if consumer behaviors change to the negative, they affect these firms. Because without any users, they're not really worth anything, right? So consumer behavior should be the number-one focus.
Now for years, consumers have had that special relationship with these big internet companies, right? I mean, their apps are easy to use, so you become very friendly with the company and its products, very familial. And I think a lot of users took that for granted and basically said, these guys, they can do no wrong, right? But now consumers are questioning that. They're considering, have we given too much power or too much of our privacy away?
And so what we're going to be watching over the next 3, 6, 12 months is, are consumer behaviors going to change? And are consumers, perhaps, going to demand a new social contract from the big internet companies?
I want to shift gears a little bit and talk about some company-specific news. We heard last week that Apple could potentially create their own chips and move away from their relationship with Intel. What's the story there? What can you give us in terms of some background?
Right, so by way of background, there's really two rival computing systems out there. There's something called ARM, and that dominates the mobile ecosystem, and there's something called x86, and that dominates PCs, laptops, notebooks, all that stuff. So Apple, for years now, has been designing their own ARM-based chips and putting it in its mobile devices-- so the iPhones, the iPads, right?
But as far as the Macs are concerned, they've always been buying Intel x86 chips. So the news we got last week-- the rumor, to be perfectly clear-- is that Apple is going to go and out-engineer Intel, basically create its own chips based on the ARM architecture for the Macs, and Intel is going to lose that portion of the business.
I know we're commenting on a rumor, and I'm potentially asking you to look into a crystal ball here, but how likely do you think it is that Apple actually does this? And if it does happen, how material could it be for both companies?
Well, Apple does have a record of making architecture changes in the past that are good for its business. But the question here really is, will this be good for the business?
Now first we should ask ourselves, is Apple a competent semiconductor design company? No question, they've designed every single chip that that's gone into the iPhone, themselves. And they've done a very good job of it. But ARM is really an unproven technology in the PC ecosystem. And they've tried to penetrate that system before, but they've always failed.
Now ARM is making a new push into the space, and they've partnered with Microsoft and Qualcomm. And they're trying to get into some Windows devices. But really, they're not a player in this space right now.
And as far as impact to companies, financial impact, there was a big overreaction for Intel when the stock fell 9% on the news. We can do the simple math around this. Apple shipped 19 million Macs last year. And if we take about $150 of Intel content per Mac, that gets us to a revenue impact for Intel of about 3% to 4% per year. Now that's a meaningful number, but really not material in the big scheme of things for the company, especially when you consider that this is a rumor and, even if it goes ahead, it might not be across the entire Mac line and not until 2020. And as for Apple, this is really not a material development for investors.
I want to close things off by asking you a little bit about earnings. As an investor, we're heading into earnings season. What are some of the things that we should pay attention to?
Earnings season is a really good time to refocus on the fundamentals. So what we know is that the IT spending environment continues to be very healthy. Some of the best themes out there include digital advertising, cloud deployment, and, broadly, software. Now we know that back in 2017, sales and EPS growth for tech was better than any other sector-- ex-energy and the volatile commodity sectors. And really in Q1 and in 2018, we expect more of the same, high single-digit to low double-digit earnings and sales growth.
As far as our own investment philosophy, we continue to adhere to the same principles of investment excellence, meaning investing in companies that are well run, have the best products, and have a big moat around their business. In the US, we can point to Microsoft, Apple, and Intel as companies that meet that criteria. And here at home, CGI and Constellation Software come to mind.
Vitali, thanks for being here. You've given us a lot in terms of the regulatory piece, companies to look at, and even how investors should think about earnings.
Thanks for having me.