Examining the Tech Sector through the Pandemic – and Beyond

Global Technology Portfolio Manager Denny Fish believes that many of the people and businesses who’ve relied upon technology during the pandemic will continue to do so once the crisis abates, complementing the already powerful tech trends of the cloud, artificial intelligence and IoT.

Key Takeaways

  • The timeline that we expected for e-commerce, remote work and social media platforms to gain a greater foothold in society has been pushed dramatically forward due to the COVID-19 outbreak.
  • Rather than an ephemeral spike, we believe many of these behaviors will last long after the virus subsides, complementing the already powerful tech themes of the cloud, IoT and artificial intelligence.
  • Near-term risks remain, especially in pockets of the semiconductor complex that have exposure to economically sensitive sectors.

The global economy has suffered a fierce blow as the COVID-19 pandemic has spared few – if any – regions and industries. Equity markets have followed suit as the hit to near-term earnings prospects and uncertainty about when and how the global economy will ramp up is factored into stock prices. But restart, the economy will. And integral to this process, in our view, is the technology sector. In fact, on display over the past couple of months are examples of how much individuals and companies have already come to rely upon technology in their daily lives.

An Accelerated Deployment

We believe the tech sector is a driving force in the secular themes that will redefine how we work, shop and socialize over a three- to five-year time horizon. Many of the companies exemplifying the themes have been called into action – perhaps earlier than anticipated –  to help businesses and societies navigate the COVID-19 crisis.

Businesses have been forced to deploy the capabilities required for remote work. People have increasingly relied upon social media platforms to communicate. Online grocery shopping has gone mainstream. Many cohorts, including older generations who have been hesitant to embrace the digital economy, have been compelled to do so. It’s no longer optional.

With families sequestered at home, theaters closed and sporting events canceled, streaming entertainment and gaming have become go-to diversions. As with e-commerce and social media, the growth outlook for these services was already promising; what has changed is the pace at which they have been adopted by broader swaths of the population.

In this respect, the expected benefits of recent capital expenditures by these companies was likely pushed forward. Amazon has invested heavily to roll out one-day shipping. With shops shuttered, this initiative helped customers stay well supplied while they shelter in place. Furthermore, we have witnessed retailers across the spectrum rapidly ramp up their e-commerce capabilities to better meet the shifting demands of customers.

Something for Enterprises

The cloud is another secular theme that has helped companies accelerate their digital transformation. Cloud-based front-office functions are helping businesses of all stripes keep doors open, and other functions are increasingly leveraging the cloud as staffs work remotely. Until now, business continuity plans had not been tested at this scale. Going forward, businesses will make sure they have the digital infrastructure necessary to maintain operations. Accordingly, we expect a reprioritization of investment, with a much greater share of expenditure going toward strengthening digital capabilities.

Cyclical Headwinds Emerge

Other segments of the tech sector have found the past couple of months more challenging. Companies with more exposure to the economic cycle have suffered as global growth prospects have fallen. The semiconductor complex has been hit hard by a convergence of factors as chipmakers were only beginning to climb out of an inventory overhang when the pandemic erupted. We believe that the longer term prospects of semiconductors is bright, given the critical role they play in the deployment of cloud data centers, the Internet of Things (IoT) and artificial intelligence (AI), but their exposure to global supply chains and the COVID-19-related demand destruction have weighed on the industry. Certain segments of semis are more sensitive to the economic cycle than others, and some names are particularly exposed to industrials and automotive, areas that likely face acute near-term headwinds.

Maintaining a Balance

We believe that the lenses through which we view the tech sector help us stay focused on the sector’s long-term drivers, as well as identify near-term challenges. We tend to view tech companies as either displaying more resilient characteristics or possessing  optionality, meaning the possibility of rapid earnings growth.

The appeal of a company’s resilience is on display during periods of economic upheaval. Companies whose sticky products can generate steady cash flows across the economic cycle, along with those that don’t rely upon a high degree of leverage to fund growth, are likely to come out of downturns largely intact. Changes in consumer preferences and opportunities presented by economic disruption, on the other hand, can increase the optionality profiles of younger, more nimble companies.

We also divide the sector between cyclical growth and secular names. While cyclical companies will contribute to the sector’s fortunes when the economy is on the upswing, we believe it’s secular growers that will power the digitization of the global economy in the years to come.

Economic Growth Welcome but not Required

Should the economic slowdown last over the mid-term, we believe investors will seek earnings and cash flow growth where they can find it. Propelled by the themes of cloud, IoT and AI, the tech sector should continue to be a preferred destination. Should the crisis wear on, the relative strength of tech balance sheets should also prove desirable. If the health situation stabilizes and policy stimulus ignites economic growth, more cyclical tech names may also see their prospects improve.

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