The prospect that the coming midterms in the U.S. could be tampered with by an outside force is one of the biggest fears facing election watchers. It could also prove to be an opportunity for investors looking for a growth story with coming catalysts.
High-profile hacks and data breaches have long been a tailwind for cybersecurity companies, as the crimes underline the need for the services and contribute to rapid growth. With the coming election seen as a major target, this trend could continue, according to Goldman Sachs.
The investment bank wrote that cybersecurity stocks “present a tactical opportunity ahead of [the] midterm elections” in November. Citing press reports that “suggest rising concerns about the possibility of meddling” in the election, it wrote that a rise in security spending “in anticipation of potential threats would boost the top-line of cybersecurity stocks.”
The midterm election is already seen as a wild card factor that could amplify market volatility, and prospect of external interference could only heighten that sense.
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The issue is seen as particularly potent after U.S. intelligence agencies concluded in January 2017 that Russia sought to influence the election in favor of President Donald Trump over Democrat Hillary Clinton. On Friday, 12 Russian intelligence officers were indicted for hacking into the Democratic National Committee’s server, as well as the Democratic Congressional Campaign Committee and the presidential campaign of Hillary Clinton.
While the Trump administration has sanctioned Russia for interfering in the election, Trump himself has indicated he believes Moscow’s side of the story, recently tweeting that “Russia continues to say they had nothing to do with Meddling in our Election!”
In May, Secretary of State Mike Pompeo said the Trump administration wouldn’t tolerate Russian meddling in the 2018 congressional midterm elections, and that the administration would take “appropriate countermeasures” to fight what he called “continued efforts” by Russia to meddle in November’s vote. He didn’t offer details on either Russia’s interference or the countermeasures.
Beyond the election issue, Goldman sees a fairly favorable landscape for the industry. “Reasonable relative valuations and favorable fund positioning relative to history should benefit fund returns,” it wrote to clients. “Exposure to high-growth stocks, insulation from tariffs, and stronger-than-average balance sheets also represent near-term tailwinds to cybersecurity stocks despite their mixed long-term outlook.”
Citing a survey it did of IT spending, Goldman noted that 45% of corporate chief investment officers expect to accelerate their spending on security. No other category neared this level.
According to Goldman, cybersecruity stocks are expected to post sales growth of 9% in 2019, a rate that would be above both the overall technology sector (which is seen growing revenue by 6%) and the overall market, as measured by expectations for 5% growth among all S&P 500 components. The sector also trades at “below-average relative valuations,” it wrote, using the metric of enterprise value to sales.
“Valuation expansion has been a key driver of cybersecurity outperformance this year and room remains for further expansion given reasonable relative valuations compared with the past five years. In addition, year-to-date consensus sales revisions for cybersecurity stocks have exceeded the S&P 500 (+2.2% vs. 1.8%), a trend which should persist if security spending accelerates ahead of the midterms.”
There are two exchange-traded funds that track the cybersecurity sector, and both have handily outperformed the broad market thus far this year. The ETFMG Prime Cyber Security ETF HACK, -0.13% is up 23.4% thus far this year, while the First Trust NASDAQ Cybersecurity ETF CIBR, -0.32% is up 19.8%. The S&P 500 SPX, +0.14% is up 4.8%, while the overall technology sector is up 15.4%.
According to FactSet, $280 million has flowed into the ETFMG ETF thus far this year, bringing its assets to $1.6 billion. The First Trust fund has had $254.6 million in year-to-date inflows, which accounts for a sizable portion of its $705.6 million in assets.
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Despite the positive valuation trend, Goldman wrote that its long-term outlook was “more mixed” on the industry.
“It has been difficult for companies to consistently generate value for shareholders in the space and as such, longer-term investment opportunities are scarce.”