As Markets Capitulate, “Tech” Stocks Still Present the Best Bet

By James Cakmak and Ryan Guttridge

Inflation. Supply chain. Fed. Interest rates. Russia.

Each one of these terms are sounded as alarm bells everyday. In fact, the market’s oscillations are only getting more violent, exacerbated by the diminishing contribution of bottom-up investing to decisions in the market.

Amid this “panic selling”, everything is getting crushed:

1. Value stocks are getting crushed because of concerns around inflation
2. Growth stocks are getting crushed because of concerns around rising interest (discount) rates
3. Indices are getting crushed because of concerns around geopolitical factors

While all of the above are independent, the cause of confusion is the same: mean reversion. In other words, rising capitulation by investors that slowing growth rates are a new normal.

The reality for many “tech” stocks, however, is that growth rates are likely to prove steeper and more sustainable than current expectations suggest. Hence, they should revert back to the mean, and probably edge even higher.

Averages Matter

Before getting into it, it’s important to underscore two points:

1. Stock prices are largely driven by how a company operates on average over the long term
2. This performance is around an average, but NOT exactly on the average

The first point is fairly straightforward, however, the second is deceptively nuanced. An “average” is a gigantic simplification of a series of data points. Surprisingly, in a series of data, the average almost never occurs. The data will wobble around our simplified description by varying amounts, sometimes lower, sometimes higher.

Some companies materially accelerated during Covid, while other companies suffered startling decelerations. It’s important to recognize that many of the behavioral changes were going to happen no matter what, albeit more gradually. The lockdowns simply forced the adoption almost overnight.

Amazon is a perfect example of this. The company enjoyed roughly 20% annual revenue growth like clockwork prior to Covid. As the lockdowns ensued, growth exploded higher, more than doubling in 2020 to over 40%. Now the company’s annual growth rate has plummeted to single digits. This is because we are comparing against the higher Covid numbers, which was 9% in 4Q21.

Here’s Amazon’s growth trend below from 2019–2021:

The question in investor minds is where Amazon’s growth rate (and every other company for that matter) will ultimately land. This uncertainty is the root of the volatility in the market, much more so than if the Fed will rate hikes by 25 or 50 basis points.

Mean Reversion Explained

We can illustrate investors’ current uncertainty through a few simple charts.

Pre-Covid Average Annual Growth Expectations

For the purposes of this example, let’s assume the estimated average annual growth rate for a tech company was 10% prior to Covid.

Covid’s Higher Octane Fuel

Once Covid hit, demand shifted up, represented by the green line. The question left unanswered during this time: “which line is the ‘right’ average?”

Covid Hangover

Post Covid, demand shifted down, represented by the red line. The question left unanswered during this time (i.e. today): “is the slower growth rate the new normal?”

Reversion to the Mean

With that baseline, now we can determine how to pick the winners and losers. The fundamental task investors face today is assessing if a given company’s growth curve is materially different from pre-Covid. In other words, were the growth rates simply a “wobble” around the pre-Covid mean with the original curve intact, or has the slope of the curve indeed changed for the better, or worse?

For longterm investors the question is simple:

• If the right slope is on the pre-Covid line or below, sell
• If the right slope is on or above, buy

Cloud-First Companies as Secular Winners

Companies with secular tailwinds are likely to revert back to historical growth rates, and potentially even higher given the permanence of behavioral changes. The world is not going back to the way it was. Most of these secular winners are in the “technology” sector, but tech is really a misnomer at this point. We define technology as any product or service that saves people time, hence our name…Clockwise.

Time saving companies have three primary attributes: (1) Innovative, (2) ability to scale quickly, and most importantly, (3) very persistent sales growth.

It’s that third point that most investors are currently underappreciating. Growth rates can not only revert back to the mean, but can be sustained longer than expected.

Walmart is a textbook example of a time savings behemoth. This is a company that grew sales by 36% on average over 30 years from 1969–1999. 30 years! Who would have guessed that degree of sustainability in the growth curve? Today is no different with many cloud-first companies.

Companies such as Apple, Amazon, and Microsoft have consistently surpassed revenue growth expectations and their stock price appreciated as a result. It’s key to realize that these companies are providing the infrastructure enabling the rise of a new class of cloud-first and time saving businesses.

Take a look at companies like Snowflake, Crowdstrike, Okta, Twilio, Airbnb. The growth rates are likely to rebound once we’ve lapped the inflated Covid numbers. Additionally the cloud enables perhaps the best business models we have ever seen, where companies can grow quickly while monetizing that growth. From this perspective, it’s clear that the market is currently underestimating the quality of business models and the size of the opportunities ahead.

The transition we’re witnessing from physically bounded to digitally unbounded growth has the ability to do for businesses what the iPhone did for consumers. Critically, we are only in the second inning of a 10+ year game. This means two things 1) consensus revenue growth numbers are too low and 2) fears of growth being even slower are completely overblown.

If Walmart is any guide, there’s a lot of money to be made.

Clockwise Capital is an asset management firm with a private equity approach to the public markets. We focus on the meaning of time and the role it plays in people’s lives. We believe the essence of a great investment resides in the ability of a company to either save their customers time, or improve its quality. We understand how technology evolves to drive these two factors, which we believe define human progress. As a result, we search for securities with cyclically depressed valuations whose companies save time, thus using secularly advantaged industries to build a concentrated portfolio. With each series of investments our goal is to optimize edge, maximize return, while also minimizing correlation. This allows our portfolio to maintain a liquid, low duration fixed income balance, ready to capitalize on market volatility, while still generating market beating performance.