Scottish Mortgage Investment Trust (LSE: SMT) is one of the darlings of the FTSE 100 index. Long-term investors who have stuck with the Trust have been generously rewarded, as its share price over the past 5 and 10 years has risen 4x and 9x respectively.
However, during the past year the Trust has only managed to deliver a 7% return. Of course, to read too much in to just one year is hardly fair, particularly given the fact that in 2020 the Trust returned a stellar 110% as global markets crashed and then staged a remarkable recovery.
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The key question for a would-be investor like myself is the likely trajectory of the share price in 2022 and beyond.
The bull case for Scottish Mortgage
One of the primary reasons I like Scottish Mortgage is how it has ripped up the rule book when it comes to investment management. The traditional approach deployed by fund managers tends to mirror the market at large: namely, quarterly earnings reports and a preoccupation with near-term price-to-earnings (P/E) ratios as the primary mechanism for defining value.
Today, there is only one constant and that is change. Scottish Mortgage managers have recognised the potent forces that are shaping the world and have been willing to place early bets where others daren’t venture – the most high-profile being that into Tesla. This trend is likely to continue, as the Trust invests 20% of its capital into unlisted companies.
As the rate of innovation continues to increase, driven by advances in the likes of synthetic biology, nanotechnology, AI, 3D printing, together with a decrease in the cost of capital needed to begin new ventures, thanks to Amazon Web Services, there is nothing to say that Scottish Mortgage won’t find the next Apple or Alphabet.
The bear case for Scottish Mortgage
The primary risk I see for me investing in Scottish Mortgage is its large exposure to the US tech sector. I myself am not averse to investing in this sector, for all the reasons just stated, but for me this part of the market has all the hallmarks of the tech bubble of 2000 and is rife for a major correction in the near-term.
Technology stocks do well in an environment when the cost of capital is low. It is no coincidence that tech stocks (and particularly software companies) have been the best-performing asset class over the past 10 years. However, we are now entering a new macro regime – one dominated by inflationary forces and an increase in the cost of capital as interest rates begin to creep up from their historic lows to tackle this threat.
In 2000, 25% of the largest US stocks were unprofitable; today, the figure stands at nearly double that. The FAANG stocks have for far too long being propping up the entire market and masking the weak fundamentals of the sector as a whole. For me, all I see is flashing red lights. The likes of DocuSign, Zoom, Peloton and Moderna have all begun to roll over. If the market does crash, then the likes of Scottish Mortgage will be one of the first in the firing line. Others will of course disagree with my arguments. What is undisputed, though, is that no bubble in history has ever ended well.