Home Brokerage Market Sentiment Suggests Tech Investors Should Continue to Proceed with Caution

Market Sentiment Suggests Tech Investors Should Continue to Proceed with Caution

by internationalbanker

By Hilary Schmidt, International Banker


On March 3, Amazon announced that it would delay breaking ground on its new corporate-development complex, initially scheduled for this year’s first quarter. The construction project in Arlington, Virginia, which is expected to house three 22-floor office buildings and create more than 25,000 jobs in the region and which the Seattle-based tech and retail giant has dubbed its second headquarters, will now be put on hold indefinitely. In so doing, it marks one of the latest signs that the tech sector is expecting a subdued outlook for the foreseeable future.

“Our second headquarters has always been a multiyear project, and we remain committed to Arlington, Virginia,” said John Schoettler, Amazon’s vice president of global real estate and facilities. Indeed, initially announced in 2017, the project reflected a thriving sector with an insatiable appetite for office space amid an unprecedented boom. But the last two years have seen several big tech firms delay or cancel plans for new office construction and engage in other real-estate cost-cutting measures, such as cancelling leases, as sentiment for the sector has turned decidedly bearish. “The one thing to hang your hat on for a lot of office owners was that tech demand,” John Kim, a real-estate stock analyst and managing director at BMO Capital Markets, recently told the Wall Street Journal. “We didn’t realise it would be this bad this fast.”

One could argue that even towards the end of this first quarter, the central banks’ unfinished business regarding monetary tightening remains the biggest drag on the outlook for technology. After experiencing significant prosperity during the COVID-19 pandemic, as lockdown restrictions across the world dramatically boosted demand for digital services, the sector hit something of a brick wall in 2022, as spiralling inflation throughout much of the year prompted the US Federal Reserve (the Fed) et al. to raise interest rates aggressively.

Rate hikes have not only curtailed demand and weighed on consumer sentiment, but they have also triggered considerable US dollar appreciation, which, in turn, has meant that tech firms’ foreign-revenue streams have been converted back to fewer dollars across recent quarters. Ninety-one recently US-listed tech firms also burned through more than $12 billion of cash in 2022, according to Dealogic data, spending a hefty 37 percent of the funds they received during their initial public offerings (IPOs) during the year. The sector is now facing serious scrutiny over how it can raise more funds, meaning that while tech stocks were the ones to send stock markets to new highs in 2020 and 2021, they have also led dramatic sell-offs over the last 18 months or so.

And with fears of a recession hitting the United States, the European Union (EU) and other major economic jurisdictions weighing heavily on the economic outlook this year, tech companies continue to introduce a raft of cost-cutting measures, including extensive layoffs. Google’s parent company, Alphabet, for instance, has confirmed that it will shed around 12,000 jobs—or 6 percent of its total workforce—in what will be its biggest-ever round of cuts, while Meta Platforms will trim its workforce by some 10,000, mostly during April and May, with Meta’s chief executive officer (CEO), Mark Zuckerberg, acknowledging that the layoffs “will be tough, and there’s no way around that”. Meanwhile, Amazon plans to cut 18,000 jobs, primarily affecting its human resources and store divisions. And Microsoft will lay off 10,000 employees—almost 5 percent of its global workforce. “We’re also seeing organisations in every industry and geography exercise caution as some parts of the world are in a recession and other parts are anticipating one,” Microsoft’s CEO, Satya Nadella, explained.

Sharply rising borrowing costs are also being held chiefly responsible for the recent collapse of top tech-sector lender Silicon Valley Bank (SVB), which was closed by regulators on March 10 as it experienced a massive run with depositors withdrawing substantial sums. SVB, the 16th largest US commercial bank, was left overexposed on its bond portfolio, which had drastically diminished in value following the Fed’s recent series of sharp rate hikes. This was further compounded by a surge in demand from its tech-firm customers, as the tech sector came under increasing pressure to raise funds and focus on cash generation. “They were super exposed to tech venture capital depositors who had been seeing cash burn as the tech bubble burst, while previously having loaded up their balance sheet with positive carry trades into bonds when deposits soared during the tech boom and ultra-low rate environment circa 2021,” Deutsche Bank analysts recently wrote in a note to clients.

And while US regulators have moved quickly to guarantee all SVB customer deposits to prevent further bank runs and ensure tech firms can continue funding their operations, the impact felt across the banking sector could spell further disaster for the tech sector. Indeed, HSBC intervened on March 13 to buy Silicon Valley Bank UK for just £1 to safeguard the deposits of thousands of British tech firms and prevent the bank from entering insolvency. HSBC CEO Noel Quinn said the acquisition “strengthens our commercial banking franchise and enhances our ability to serve innovative and fast-growing firms, including in the technology and life science sectors, in the UK and internationally”.

But somewhat perversely, SVB’s collapse could actually aid the tech sector by putting the brakes on rate hikes in the interim as regulators scramble to contain the contagion risk across the broader financial sector. “In light of the stress in the banking system, we no longer expect the FOMC [Federal Open Market Committee] to deliver a rate hike at its next meeting on 22 March (v our previous expectation of a 25 basis point hike),” Goldman Sachs analysts wrote in a note to clients, meaning that the US bank expects the Fed to maintain rates at the current level of 4.5 percent to 4.75 percent.

Indeed, the tech-heavy Nasdaq-100’s rally since March 10 suggests that the market is reacting positively to the likelihood of a pivot by the Fed, at least in the short term. As such, investors may be inclined to place temporary bets on the tech sector during this period. But given the raft of longer-term woes plaguing the industry, resulting in most analysts delivering lower earnings estimates, boosting investors’ exposures to the tech sector remains a rather risky move at present, with any contingent pause in rate hikes likely to prove something of a false dawn. “The demand side is where the uncertainty is,” Kim Forrest, chief investment officer at Bokeh Capital Partners, told Bloomberg in mid-February. “You can do something about the cost side, but at the end of the day if your customer doesn’t feel like your product is adding value at this time, then you’re going to have a shortfall.”

And while the Nasdaq-100 has comfortably outperformed the S&P 500 (Standard and Poor’s 500) to date this year, history tells us that such a situation is invariably followed by a reversal of fortunes, with the Nasdaq going on to underperform. Nicholas Colas and Jessica Rabe, co-founders of market data provider DataTrek Research, reportedly noted that since 2010, there have been 12 instances during which the Nasdaq outperformed the S&P 500 by five percentage points or more. But in each case, the Nasdaq went on to underperform the S&P’s benchmark index. “Our data-driven approach tells us to be cautious on NASDAQ/US Large Cap Tech here,” DataTrek recently noted, as reported by Business Insider. “They’ve had a great relative run versus the S&P 500, but +12 years of market history says it is time to be more cautious.”

Ultimately, then, investors ought to remain wary of boosting their exposures to tech, particularly given the precarious nature of the global economy and the clearly restrictive impact it is having on the sector at present. With inflation still far from being brought under control, moreover, any imminent pause in rate hikes is unlikely to spur a sustained economic recovery anytime soon. And with even Mark Zuckerberg labelling 2023 as the “Year of Efficiency”, it seems wise to proceed with caution until companies can demonstrate their resilience.

 “Beleaguered by softening consumer spending, lower product demand, and falling market capitalizations, many tech companies’ C-suites are feeling the urgency to increase margins and grow revenues,” Deloitte wrote in its “2023 Technology Industry Outlook”. “Beyond workforce adjustments, approaches may include making business processes more efficient, relying more heavily on intelligent automation, modernising legacy architectures, and considering strategic mergers and acquisitions.”


Related Articles

Leave a Comment

This site is protected by reCAPTCHA and the Google Privacy Policy and Terms of Service apply.