Despite the recent rotation toward cyclical stocks, Denny Fish explains why secular-growth companies should remain the main driver of tech earnings over the next several years.

Key Takeaways

  • While an economic reopening should benefit cyclical tech stocks, the sector’s long-term prospects are still closely tied to the powerful themes of the cloud, artificial intelligence and Internet of Things.
  • Digital adoption increased during the pandemic and we doubt businesses will revert to less-efficient methods once economies fully reopen.
  • Investors should be mindful, however, that the level of digital engagement in certain activities may shift as in-person interaction increases.

With vaccination rates increasing globally and economies reopening, investors have been on the hunt for beaten-down pockets of the market that stand to benefit from rising economic activity. Consequently, the high-growth technology and communications stocks that were among the best market performers during the depths of the pandemic – while not entirely shunned – have taken a back seat to more economically sensitive names. But the secular themes that propelled several mega-cap tech companies over the past few years are not going away. We believe that the complementary themes of artificial intelligence (AI), the cloud, the Internet of Things (IoT) and the 5G connectivity that binds them will remain the primary drivers of tech sector earnings over the next decade.

Quite Disruptive

These mega-themes are pulling the world’s economy toward an increasingly digital future. There is little place to hide; either companies – and entire industries – must undertake digital transformations to improve both front-office and back-office experiences or risk getting displaced by more forward-looking, disruptive peers.

Importantly, this transformation is occurring across all business sectors. Households too – and not just digitally enabled Gen Zers – are integrating technology into everyday tasks. These trends accelerated during the pandemic as companies and families sought to navigate a world of social distancing. But although adoption has been pushed forward, it is by no means primed for a lull. Functions ranging from e-commerce to cloud-enabled remote working, for many, represent a “better mousetrap” and we doubt that entities will want to return to less-efficient ways of doing things once the global economy and society normalize.

About That Return to Normal

Having digital-enabled efficiencies take root across an array of tasks, however, does not mean that certain activities and methods prevalent during the pandemic won’t revert toward some pre-lockdown status quo. Which ones is a question that investors have been pondering for much of this year. We believe that these activities – and the prospects for companies associated with them – fall into three categories.

Gamer in headphones sits in front of a blank monitor in dark room

First are activities that should find their pandemic level of engagement difficult to match. Exemplifying this category is online gaming. Gaming enjoyed a considerable boost during lockdowns but with competition from offline activities likely to make a comeback – and days only having 24 hours in them – engagement metrics, along with earnings of game creators, will find it difficult to match 2020’s torrid rise.

The fate of the second category is more difficult to ascertain. Here, we find communications tools that enable remote work, learning and interaction with socially distant friends and family. As businesses and schools transition – to some degree – back to in-person work and schooling, the levels at which these “go-to” pandemic services will be relied upon going forward is uncertain. Despite this, we believe that these services will continue to be tapped, especially as many businesses adopt hybrid work models and video calls displace last-minute – and often expensive – business trips.

Last is the category of activities adopted during the pandemic that likely has room to run as they are more closely aligned with longer-term themes. Among these are digital payments, the growing acceptance of digital signatures, online exercise classes and food delivery. In our view, these services are on the right side of the digital divide and should further benefit from pandemic-driven behavioral changes.

Powering the Future

While the mega-cap tech and communications companies that buoyed markets during the pandemic are now sharing the spotlight with more cyclical names, they maintain certain competitive advantages that are hard to match. Increasingly, these companies are powered by their ability to collect, analyze and leverage data. As data becomes the currency of identifying business trends and wringing out efficiencies across the economy, these platforms stand to create a flywheel that results in unit economics unlike anything the tech sector has previously seen.

With data being the linchpin and the cloud, AI, IoT and 5G connectivity only gaining greater traction, it is our view that technology will garner an ever greater share of corporate and government expenditure and, thus, account for an increasingly larger share of global GDP.

The Right Side of Disruption