Rapid structural change continues unabated in the information technology (IT) sector, with mobility, cloud computing and the internet of things all redefining the way we think about technology.
In 2023, the largest impediment to price appreciation for high growth stocks was rapidly increasing policy rates. In addition, aggressive forecasts for growth companies were extrapolated well out into the future following the transformative shifts in the global economy seen during the pandemic. It eventually became clear, however, that some of these expectations were overly optimistic. As a result, valuations compressed more rapidly than in any period since 2008.
With inflation softening, interest rates moderating, and more attractive price levels, investors are now reconsidering allocations to higher growth, innovative businesses.
There are still many risks not to be overlooked. The US Federal Reserve may remain hawkish for longer than expected to impede inflation or to regain credibility at the expense of the economy and asset prices. Long-duration assets may underperform in such a scenario.
Back to the pre-pandemic paradigm?
In our view, the upside risk to terminal rates in this hiking cycle has moderated as economic growth decelerates and inflationary pressures slowly abate. The weakness in consumer spending on personal computers and low-end smartphones could spread to commercial and corporate customers, as well as to Covid beneficiaries such as the e-commerce sector. These segments might underperform as adoption and market shares revert to pre-pandemic trends.
A strategic imperative
While there are likely to be further negative earnings revisions as the economy slows, we see the potential for the technology sector to outperform given the historical resiliency of earnings during recessions.
Many companies see digital transformation as a strategic imperative, which should support enterprise IT spending. Cyber security, for example, is one area we expect to hold up even if companies reduce their IT spending in 2023.
Semiconductor demand may also prove to be robust in end markets including the auto sector — where electronic content is increasing and inventories remain low — and data centres, depending on the resiliency of spending on such facilities to support cloud and artificial intelligence (AI) initiatives.
Generative AI breaks to the upside
Generative AI – artificial intelligence technology that can produce various types of content including text, imagery, audio and synthetic data – has recently hit an inflection point in capability and use.
Generative AI capability is likely to be embedded in many software services. There have already been announcements from market leaders that they are leveraging this technology.
We believe generative AI will accelerate the adoption of AI to the point where it becomes ubiquitous. Machine learning AI is rising versus legacy rules-based AI, that is, AI models that learn from the data provided to them rather than from specific rules that are coded in. The change really began to accelerate around 2010 with the confluence of low-cost computing and storage, the existence of massive data sets, and advancements in algorithms within the AI field.
Driving demand for semiconductors
There is significant demand driver for semiconductors as the amount of computing resources consumed rises exponentially with successive iterations of generative AI systems. Semiconductors for high performance computing are physically very large. Semiconductor companies are trying to balance performance versus power consumption and are hitting some limitations with respect to Moore’s Law (the observation that the number of transistors in an integrated circuit doubles about every two years). Microchips are getting larger with each generation. This drives wafer demand faster than unit demand, which is positive for semiconductor capital equipment and materials companies in the long term.
Secular growth supports tech
We remain confident in the durability of the secular growth drivers that underpin our strategy – cloud computing, artificial intelligence, automation, and the Internet of things – as well as the foundational technologies that enable these themes. We continue to believe that the leaders and the beneficiaries of the digital transformation will deliver superior revenue growth, earnings, cash flows, and returns over a long-term investment horizon as companies strive to cut costs, operate more efficiently, and innovate to differentiate.