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On your marks
MONTHLY INVESTMENT BRIEF
08.11.2022
Co CIO
ODDO BHF
Portfolio Manager, Artificial Intelligence
ODDO BHF AM
“ The question now is whether we are facing a long cycle of underperformance or whether tech stocks are becoming attractive again „
2022 : TECH’S ANNUS HORRIBILIS
-39.8% for the IGV (US Software sector ETF), -
39.2% for the SOX (Philadelphia Semiconductor
Index), -42.4% for the Hong Kong Tech Index.
2022 can already be described as an annus
horribilis for the global tech sector, after several
years of relentless performance.
Each segment of the industry has gone through a
long and throbbing downward phase in 2022 that
ended in violent retreat. First, Chinese technology
stocks. Then, Semiconductors followed by GAFAM.
And finally, the Software segment which collapsed
on 4 November 2022.
This historic decline is part of a broader sector
rotation movement. Flows are moving out of tech
(and in particular GAFAM) into two types of
sectors:
- Cyclicals (Energy, Financials and Industrials)
- Defensive: sectors with relatively stable earnings expectations during a recession (Pharmaceuticals and Food)
The question now is whether we are facing a long cycle of underperformance or whether tech stocks are becoming attractive again.
We see reasons to be more constructive from now on:
- The segments that capitulated first (Chinese tech and Semiconductors) are rebounding
- Some semiconductor companies have already revised their forecasts three times and are now presenting a more de-risked level of expectations
- Valuations have returned to attractive levels for long-term investors. For example, it is not uncommon to find companies with double-digit growth rates along with valuations close to those of the Telecoms sector
- The sector’s fundamentals remain excellent and there are no leading indicators that the semiconductor super-cycle is about to turn around
To answer that, several prior questions need to be
addressed first :
➢How high will US interest rates go?
The Fed is adapting its strategy by reducing the
magnitude of future rate hikes while remaining
adamant to raise the terminal rate ever higher. It is
therefore data-dependent, in particular on how the
labour market will perform, a key parameter to
avoid a price-wage spiral. However, we believe a
pivot of the Fed has begun and that most of the
monetary tightening is behind us. The Fed will want
to measure the impact of its monetary policy on the
economy and is rightly concerned about a possible
dip in the housing market. The rise in short rates is
certainly not over, but the rise in long-term rates
may well be...
Our scenario: stabilisation of long-term rates
➢Should we expect further downward revisions
to the 2023 earnings?
We think so because analysts' forecasts lag during
recessions and some companies tend to model in
their guidance only the level of deterioration
already experienced (and not the one yet to come).
Our scenario: a decline in EPS at this point in the
cycle
➢Is further multiple compression to be
expected?
We do not think so. On the contrary, future
disappointments will be offset by an expansion of
valuation multiples; this is what previous crises
exists have shown, especially if rates stabilise and
even more so if they fall.
Our scenario: No multiple compression with stable
rates and normalisation of the supply shock
➢Have we witnessed the beginning of the end of
GAFAM (Google, Amazon, Facebook, Apple
andMicrosoft)?
The index market cap weight of these 5 companies
is so large (around 25 % of the S&P) that an
"idiosyncratic" analysis of these stocks must be
carried out. The history of the tech sector is made
up of the rise and fall of big names that end up being
disrupted and replaced by new generation, more
innovative players. The considerable loss of value of
these five stocks in October and November could
lead us down this path. Yet, we will not be drawing
such a conclusion.
We remain very constructive on Microsoft for its
ability to grow sustainably on key segments such as
Teams, Cybersecurity, or the Power Platform. We also remain positive on Google for the resilience of
its core business and its investments in AI (Waymo,
Calico, Verily). This is less the case for other
companies whose EPS outlooks have recently been
divided by 4, with the outlook for advertising
revenues in particular revised downwards. Apple's
Smartphone segment is also turning negative and
will impact the valuation of the stock, according to
our analysis.
Our scenario: a natural selection will happen and
break the “GAFAM” theme
➢Can we expect the US-China tech war to ease?
We do not think so. The interests around artificial
intelligence, the interweaving of supply chains in
semiconductors and hardware, and therefore
Taiwan, are too antagonistic to hope for a halt or a
slowdown in the pace of restrictions.
Our scenario: a status quo would be the most
optimistic scenario
➢Should we expect other tech areas to break
down as well?
Infrastructure software such as ERP (SAP, Oracle,
Workday) is clearly at risk if the recession
intensifies, as is a larger share of semiconductors
that service themanufacturing sector.
Our scenario: in this context, we recommend
favouring sectors that have already collapsed
In conclusion, which catalysts will fuel a recovery in
the sector?
- A pause in rate hikes
- An end to earnings downgrades (some segments are even recovering six to nine months before the earnings low)
- The resumption of the M&A cycle
- The arrival of opportunistic and activist investors in undervalued stocks
If these criteria were met (we are getting close), we would focus first on emerging market technology, then on semiconductors, and finally on software. In other words, the end of China's zero-covid policy could be the catalyst for a shift to “risk-on” mode in the portfolio, which would undoubtedly benefit the technology sector. On your marks...