Opportunity: Capturing the interplay between technology and quality dividend companies

The US technology stocks of the Nasdaq 100 have performed exceptionally well in 2023. The total increase in value in the first half of the year was around 39%, which corresponds to a significant excess return compared to the market as a whole. It was the best first half of a trading year in the history of the Nasdaq. Quality dividend stocks with a focus on substance only achieved around 6% in the comparable period. This is not surprising: historically, both styles have a negative correlation when adjusted for market beta. This characteristic can be used to build a long-term diversified equity portfolio.

Technology: high returns, high volatility
Technology companies typically offer characteristics such as innovation, disruption potential and rapid growth. It is often investors' euphoric expectations for the future that cause prices to rise. It is therefore not surprising that the technology sector has achieved by far the highest total return of all large investment aggregates over the past 35 years, rising more than one hundred-fold. At the same time, we have witnessed phases with massive losses of over 80% in some cases. These extreme fluctuations require massive risk tolerance on the part of investors in order to withstand paper losses and maintain focus on their long-term objectives. In general, the share prices of technology companies tend to be highly volatile and can suffer considerable losses very quickly if the market environment deteriorates.

Dividend aristocrats: “opposite” of technology
In contrast, quality dividend companies typically benefit from a solid financial base, consistent earnings (which form the foundation of reliable dividend yields) and constrained, but more predictable, long-term growth potential. A well-known example are the so-called dividend aristocrats – companies that have consistently increased their dividend payouts per share for 25 years or even longer. The share prices of these companies exhibit low volatility and accordingly suffer less in down markets. The maximum loss in the past 35 years is less than 50%, in contrast to the previous example. Also worthy of note is the fact that high barriers to entry ensure higher pricing power, enabling quality dividend companies to pass on inflationary pressures to their customers. The fly in the ointment for investors is that the long-term nature of the business model reduces upside potential in strong market phases – as in the first half of 2023.

These structural differences result in the aforementioned negative correlation between the two investment styles not only this year, but also over the long term after allowing for market beta. A strategy built around these structural differences can play out its advantages through the full spectrum of market phases. When liquidity increases in the financial markets, it supports economic activity. As a result, investors focus on growth and technology companies. If, on the other hand, liquidity falls, the need for security increases. As a result, the focus is on value and quality dividend companies. As a rule, technology shares act as performance drivers during economic expansion, while quality dividend shares behave comparatively less volatile during contraction.

Combining both styles
Even a passive buy-and-hold approach can deliver good results, as both styles outperform the broad market over the long term. However, a far more efficient strategy typically involves the active management of both building blocks. The prerequisite for this approach to prove effective is the early recognition of the respective investment environments, and thus the appropriate change of style depending on the liquidity and economic cycle. The stages of the cycle can be determined indicatively with liquidity leading indicators.

By reallocating between technology and quality dividend stocks in a timely manner, the advantages of both styles can be combined to profit in growth phases and yet be defensively positioned during periods of contraction. By liquidity, we are referring to the sum of all monetary aggregates available to the market in the form of financing and credit.

Now may be the time to act
The first half of 2023 has shown a surprisingly stable upward trend on the stock markets. Large technology companies in particular have seen price jumps. Restrictive monetary policy reduces liquidity in the market and is increasingly a negative factor for the economic environment.

Consequently, quality dividend stocks rather than technology stocks are likely to come into focus. It is important to keep an eye on the relevant indicators. We expect this to pay off in the period ahead, as it has done in the past.