As Nasdaq Climbs, Investors Should Look to New Breed of Tech Titans

With the Nasdaq back around 5000, some investors may be suffering from tech-market acrophobia. The last time the composite index climbed this high—March of 2000—the tech balloon burst.

Fear of such heights is understandable, but investors shouldn't shy away from an evolving sector that offers opportunities and ample reasons for optimism, according to the Global Investment Committee (GIC), a group of seasoned investment professionals who meet regularly to review their asset allocation models for Morgan Stanley Wealth Management clients, as well as the economic and political environment.

In particular, the GIC believes investors should diversify their tech exposure by owning leading companies in SMAC—security, mobile/social, analytics and the cloud—key tech growth areas that the GIC believes may produce strong returns.

Today's tech companies bear little resemblance to the makeshift operations that quickly burned through cash more than a decade ago, says Adam Parker, Morgan Stanley & Co.’s Chief US Equity Strategist. In 1999, fewer than half of tech companies were profitable. With some notable exceptions, around 90% of tech firms now have positive operating margins. Compared with other market sectors, technology also has the highest free-cash-flow yield, a key gauge of financial health and strength. On top of that, tech companies account for more than one-third of corporate America's $1.7 trillion in cash holdings.¹

Several key industry trends underpin the GIC’s thinking on SMAC. First of all, security, analytics and cloud computing are 2015’s top-three spending priorities for chief information officers (CIOs), according to a Morgan Stanley & Co. survey of 100 US and 50 European CIOs (see chart). The GIC also expects mobile computing to be an important focus, as users spend more time on devices and companies ramp up advertising spend and mobile payment capabilities.

“We believe that companies levered to these key secular growth areas will continue to be differentiators,” says Casey Galligan, Morgan Stanley Wealth Management Market Strategist.

Specific strengths of SMAC include:

• Security: For the past two years, industry surveys have shown that security is the top spending priority for corporate CIOs—not surprising given recent high-profile security breaches. With security, CIOs also rely on external expertise more than in any other tech category.
• Mobile/Social: Thematically, 2015 is about mobile and video. Ad spending on mobile devices is expected to continue to take market share from other platforms, as users spend more time on these devices.
• Analytics: With companies collecting more data than ever, data-analytics software has become essential, which augurs robust growth for data-analytics companies that provide economic, scalable and value-added solutions to customers.
• Cloud Computing: Customers will ultimately look to use fewer rather than many public cloud-computing systems to better integrate workflows, analyze data and simplify operations.

To be sure, tech investing still holds risks. In particular, “monetary tightening could trigger a sell-off that would be especially hard on high-growth tech companies, and concerns about global growth could reemerge and force customers to cut spending,” says Vijay Chandar, Morgan Stanley Wealth Management Market Strategist. What’s more, some SMAC stocks may have already priced in high growth expectations, he adds, setting a high hurdle for companies that leaves little margin for error.

Investors need to keep these familiar risks in mind, Galligan says, but they also shouldn't lose sight of how “the tech landscape is far different from the last time the Nasdaq was at these levels.”