Few sectors have thrived in 2022, but technology has been particularly difficult. The Nasdaq Composite is down over 30% for the year to date, with some of the highest profile technology names – Meta, Amazon – down considerably more. But with inflation apparently past its peak and with it, a potential turn in the interest rate cycle, could 2023 see a revival for the unloved technology sector?
Technology sector valuations have made a significant adjustment over the course of 2022 in response to higher interest rates. That adjustment is now largely complete. However, even if inflation were to peak and interest rates to stop rising, there seems little hope of the monetary policy cycle reversing. As such, this in itself is unlikely to be a catalyst for a significant re-rating in share prices in the year ahead.
Equally, it is difficult to paint a particularly bright future for the technology sector’s former darlings and (still) largest companies. The Fangs (or Faangs or FAAANMGs as they became) continue to dominate the Nasdaq even after a tough year, along with most technology indices: Meta (formerly Facebook), Amazon, Microsoft, Tesla, Alphabet (Google) and Apple form 43% of the Nasdaq.
While Apple and Microsoft continue to thrive, albeit at slower pace, the path to growth for Meta, Alphabet or Amazon is far less clear today. Meta and Alphabet are caught up in legal cases over their use of data and the real-world consequences of their algorithms, while Amazon is exposed to a weakening consumer. Some have embarked on new strategies, with little evidence of success. Meta’s Reality Labs division lost $3.67bn in the third quarter, while revenue is less than half that of the previous year.
Diverging fortunes
However, investors should not conflate the fortunes of these companies with the technology sector as a whole. Anthony Ginsberg, manager of the Han-Gins Tech Megatrend Equal Weight Ucits ETF, points out that a number of sectors within technology are still growing rapidly. Cloud computing, for example is supporting the earnings of many large technology companies, such as Microsoft, Amazon or Google.
He also highlights robotics, adding: “The US and China have fallen out, so US companies are increasingly onshoring their manufacturing. They are buying more automated robotics for their factories. They don’t have to spend a fortune on labour if they can bring in machine learning and automation. There’s a lot of activity there. It’s an area that is quite exciting.”
Gaming is another huge growth area. Microsoft recently announced a bid for Call of Duty-maker Activision Blizzard for $69bn. “Even the big technology firms realise gaming is a huge industry,” Ginsberg says. “Social media is also getting into online gaming as a source of social revenues.” Western developers are looking at the success of ‘super apps’ in Asia – which incorporate social media, gaming, shopping and payments – and trying to replicate them.
Cybersecurity has also proved resilient. Major hacking scandals, such as the Solarwinds attack on the US Federal Government, or the Colonial Pipeline attack on US oil infrastructure, have pushed governments across the world into spending more on cybersecurity. In the corporate sector, most CEOs rate cybercrime among their top concerns and have increased spending.
Shifting portfolios
Active managers have been shifting their portfolios to reflect this new reality within technology. Mike Seidenberg, manager of the Allianz Technology Trust, said: “We’ve shifted the portfolio this year from one that was focused on higher growth, mid-cap companies, to a more value orientation. The portfolio we have today is materially different to the one we had in 2020.” He also sees significant potential in cybersecurity: “It has durability even in a tough environment.”
He believes that the economically-sensitive semiconductor sector will probably lead the technology sector recovery when it comes, so that is also an area that may become a bigger weight in the portfolio over the next few quarters.
He sees 2022 as a “tough training year”. “A lot of things didn’t work and companies rationalised their spending. That makes for a more challenging sales environment, but companies should be able to navigate it better now they have dealt with it once. When the world changes, adjusting to that change takes a bit of time.”
Finding growth hotspots
The question for investors is how easily they can bypass some of the more difficult areas, to focus on these specific growth areas. The large global technology companies still form a significant part of most technology indices, so any passive investment will be weighted towards them. Even active managers may still have holdings in these companies in order not to take too much benchmark risk.
There are ETF options that allow investors to cherry-pick technology themes – cloud computing, cybersecurity, gaming. If investors go down the active route, hunting out managers that are genuinely active, rather than holding large weights in stocks that may be past their prime because they form a large part of the benchmark, is likely to be more productive.
Ginsberg believes the current situation is very different to the technology boom and bust at the turn of the century: “In 2001, companies were not on sustainable earnings. The CEOs were blowing millions on Super Bowl advertising. It’s very different now. A lot of these businesses are on subscription services – for cloud, for cybersecurity – giving regular cash flows based on contracts.”
The past decade has been the decade of the Fangs, but their success is unlikely to be replicated over the next 10 years. Technology still has plenty of strong growth areas, but investors need to make sure they are positioned for the future rather than the past.
