The long-term structural bull case for the technology sector and the relative strength of several tech firms during the recession are well established. But we believe the present crisis has also created additional macro tailwinds for tech stocks.
We have been long the technology sector through the bull market of the past few years, mainly on structural and macro grounds. We have liked its superior growth profile at a reasonable valuation, the low labour cost exposure that helped in an environment of rising wages, its appeal in a retail-driven market scenario, and its ability to support earnings growth with more levers than most other sectors.
Has the recent bear market changed this long-term structural thesis? No – the digital revolution and greater adoption of technology, from automation and artificial intelligence to cloud-based services and ecommerce, will continue apace.
But the crisis has added new macro dimensions to the investment case for technology stocks. We believe the economic lockdown, international recession, and policy responses have created or accelerated five trends that will further support the tech sector.
1. Nominal growth rates should remain lower for longer after stimulus efforts massively increase debt levels around the world. This macro backdrop suits the tech sector on a relative basis, as it is enjoying secular demand for the aforementioned reasons and so depends less on the strength of the economic cycle.
2. For the short and probably medium term too, there is a perfect alignment of factors for low inflation – rising unemployment, plummeting commodity prices, depressed demand, and so on. Low inflation can be problematic for companies with a high debt burden, but this is not in aggregate an issue for the tech sector.
3. Continued pressure on global trade and supply chains is likely to lead to some re-shoring and other ways of shortening corporate supply chains. Doing so in developed markets is likely to rely on technological solutions as recreating the relatively labour-intensive supply chains that exist in emerging markets is probably not a feasible option.
4. With the outlook for the global economy still so uncertain, companies will almost certainly want to manage costs closely and find as many efficiencies as possible for the foreseeable future. Technology will again be key to this.
5. We are entering the most complex and threatening geopolitical environment we have seen in the past 30 years, with a cold war between the US and China and a global arms race in the technology and defence industries. Vladimir Putin once said that the nation that leads in artificial intelligence “will be the ruler of the world”. Such rivalries will make supporting national technology champions a strategic priority and so this eases one of our concerns about the sector, namely the threat of over-regulation.
This combination of powerful tailwinds and fading headwinds is a compelling one, even leaving aside the favourable long-term dynamics that still make the technology sector attractive.
After the dust settles on the present crisis, the world will look different but not unrecognisable. This will be an environment in which technology will be seen as a strategic industry and where growth, pricing power, cashflow, automation, and limited supply-chain complexity will come at a premium.
The tech sector has been a leading performer for the past few years and is slightly up year-to-date, but we believe the story has many more chapters.