In the past weeks we have seen broad weakness in growth and in particular technology stocks. This is not the first such ‘rotation’ we have seen in 2021 in that sector.
Looking back to the NASDAQ correction we saw in mid-February, the index declined by -10.5%, but after this decline the index then increased to hit a new record high level in April. Investors should remember that such rotations are common in normal equity markets and do not often last long.
Another important message here is the difference between profitable and unprofitable technology stocks. The Goldman Sachs Non-Profitable Technology Basket is an index consisting of US-listed technology companies that currently do not generate profits. This index is down -26.7% since its February high, having never recovered from the last tech-sector correction in February. Conversely, technology stocks which are profitable recovered from the February decline and went on to reach new all-time highs.
The key driver of this new divergence in performance is whether the companies are delivering profitable business growth. This difference is critical. Investing in high-growth businesses which have proven their business models and are generating positive profits and cash flows is becoming a differentiated strategy to broad investing in high revenue growth companies which may not be profitable. It is likely that this renewed market focus on profitability will be critical to investment success in 2021 and beyond for investors.
In the short-term we will often see market sentiment shift, and this can cause higher volatility. But if investors can remain focussed on investing in high-quality businesses with high-growth rates in profits, these short-term moves in markets are nothing to be overly concerned about. It is the growth in profits of businesses which should drive performance of investments in the medium-term, and this is what matters most for us at Dominion.
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