2020 has been the year for tech. Why next year may be very different

2020 has been, for the large part, a year that nobody will want to relive. That is, unless you were a tech investor.

A note by Morgan Stanley noted that software stocks were up 81% on average this year, supported by a backdrop of low interest rates, the shift to working from home, and the dearth of other opportunities for tech investors. As if that wasn't enough, companies with increasing subscription revenues cut back heavily on expenses which drove up margins.

Software aside, chip stocks have jumped 54%, cloud software 71%, with the Nasdaq up 46% this year. Wherever you look within technology, there was significant outperformance against the broader market.

However, 2021 may well be a significantly different story for tech stocks. First of all, Interest rates are creeping higher as the US 10-year creeps closer to 1% - an environment in which growth stocks often underperform value. The vaccines will then likely drive demand higher for commodities, pushing up interest rates even further.

This is not to say of course that the secular growth trends that we are seeing will be reversed such as 5G rollouts, cloud computing and electric vehicles. However it doesn't change the fact that valuations for stocks on these plays are extremely rich and may lead investors to look elsewhere for opportunities.

Take a look at shares of Zoom - an unquestionable Covid winner that has been one of the ultimate beneficiaries from us all staying at home. Shares have quietly fallen 30% since their October high as doubts creep in about the company's growth. The same could well happen for the likes of cloud-based software companies which are now 83% above their 5-year historical valuation levels when looking at them from an enterprise value-to-sales multiple.

There are names within technology however that will benefit and could see strong multiple expansion when the US reopens for business. The likes of Groupon, Yelp, Expedia and Lyft all look well poised to rally as we return to normal although others within the space such as Airbnb remain expensive, whilst Uber - although it should benefit from increased ride-sharing - may be weighed down by its food delivery unit.

Tech used to be looked at as a sector, but now it is so much more than the FAANGs with technology right at the core of so many industries that investors must look carefully at each stock and fund individually before investing. There remains plenty of opportunities within the world of technology, but for 2021, it is key to look at the underlying drivers and backdrop of each company to ensure you are not overpaying for growth.

Growth has long been sexy for investors - but given the relative valuations of cyclicals ahead of what looks to be a wider reopening on the horizon, and it is important not to forget that industries such as financials and materials - long deemed unfashionable with many still below their pre-pandemic highs - may be about to see the macro foundations be laid for a long overdue stride down the catwalk in 2021.