There doesn’t seem to be much good news for tech companies these days. The fact that PC sales are expected to have fallen sharply in the first quarter, with Apple estimated to have lost 40%, sure seems ominous. Is all of tech going to be under pressure? What’s behind this, and when will it end? Those are hard questions to answer, as we’ll see, but we’ll still try.
There are fundamentals issues with tech, of course. The sudden inflation we saw last year resulted in a global trend for central banks to raise interest rates. That tends to impact tech companies because many of them borrow significantly to finance growth. There were also supply chain problems that resulted in backlogs of orders, and that obviously delays revenues. Higher interest rates and inflation also hits developing countries particularly hard because their currency weakens against the US dollar at the same time that inflation drives up prices.
Consumers are obviously pressured by all of this, and that contributes to a reduction in consumer spending on tech. Businesses are pressured because spending pressure equates to profit pressure on them, and that puts their stock price at risk. I believe that a lot of the Tech Dump of 2023, as one vendor friend of mine described it, can be traced back to the issue of stock prices.
Stock prices generally (keep that qualifier in mind, please!) track earnings, which is roughly revenues minus costs. If you want earnings to go up while revenues are going down, then costs have to go down even more. We’ve heard about the tech layoffs, and that’s one aspect of cost reduction. Another, of course, is reductions in other spending, including spending on capital equipment. Since the stuff that’s Company A’s capital purchasing is Company B’s sales, you can see how this can create one of those feedback loops.
The potential for a kind of destructive negative feedback in spending and cost cutting is exacerbated by short-selling hedge funds. Short sales of stocks, unlike traditional “investments” or “long” purchases, are designed to profit if the market goes down, but they can also force the markets down like any wave of selling. For the first time in my memory, we’re seeing investment companies actively promoting themselves as short sellers, and issuing reports to call out short-sale targets. The effect of this is to magnify any bad news, and I believe that much and perhaps most of the stock dump we’ve seen over the last year was created and sustained by short selling. When a stock goes down, whatever the reason, companies try to take cost management steps to boost the price again, and that often means cutting spending and staff.
Even the expense side of the business spending picture can be impacted. One good example is spending on the cloud, which recent reports show has declined at least in its rate of growth. On the fundamentals side, cloud spending is linked to business activity, more so than capital spending on gear, so it responds quickly to a slowing of activity. On the technical side, many companies have realized that they built cloud applications the wrong way and are paying more for cloud services than they’d need to. Thus, they can cut back to reduce costs and help sustain their stock price.
What this all means is that there are a mixture of reasons why tech spending has fallen, and some of the big reasons have little to do with the market appetite for tech products and services. The good news is that these non-demand reasons for spending pressure are relieved when the current economic angst passes. Since January, my model has consistently said that will be happening in May, and I think current financial news is consistent with that prediction. Many reports now say that the worst of inflation has passed, and that the Fed and other central banks are nearly at the end of their rate hikes. Nobody expects prices to go down much (if at all), but both consumers and businesses tend to react more to negative changes than to a steady state that’s worse than before.
There are also segments of the market that seem less impacted by these non-demand forces, and those segments have already outperformed tech in general. The most-impacted sectors of tech are the sectors that rely on direct consumer purchases. Credit-card interest has been rising and inflation has increased prices, thus reducing disposable income and making consumers more concerned about their budgets. Next on the list of impacted sectors are those that support the consumer sectors. The least-impacted sectors are those that invest on a long depreciation cycle, such as network operators and those that supply products that are typically deployed based on long-standing evolutionary planning, like data center elements.
This explains why Apple suffered more from the downturn than, say, Cisco. Apple sells primarily to consumers, and Cisco sells to businesses to support capital plans that look ahead for half a decade. Perturbations in the market will obviously have less effect on the latter than on the former, which suggests that companies like Cisco will likely see less impact on revenues in their next earnings report.
All in all, I think the Tech Dump of 2023 (or of 2022 into 2023) will end, but that doesn’t mean that tech won’t still have issues, both in the short and long term. In the short term, it will take time for spending that was reduced or deferred returns, because it will take time for inflation and interest rate changes to percolate through the economy and impact stock prices. Nobody is going to push up spending till their stock recovers, which probably means until their revenue recovers. That means the same negative feedback that drove the dump will also delay full recovery.
In the long term, tech is likely to remain a target for short-sellers because tech stocks tend to price in a presumption of growth that’s often a bit optimistic. That makes it easier for short-sellers to start a run on a stock. There are also fundamentals issues; we continue to over-hype new technologies, and thus not only overvalue companies but also risk under-investing in things that could really be important, even critical, to the tech markets in the longer term. In the end, though, the markets are driven by companies who have significant earnings growth potential, and it’s hard to see that outside the tech space. So…tech may be down but it’s not out.