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The case for Tech

29 July 2022

1. Profits should stay somewhat resilient in a downturn

a. Large Tech companies reassure by the Quality of their cash flow, a quality deemed often very much in demand in a global slowdown. This is a quality missing for many Unicorns as they underprice their services to grow which makes some vulnerable in a significant recession.

b. Big Tech can easily reduce large profit margins to increase demand.

c. Big Tech and Unicorns grow at a much faster rate because they are much lighter than competitors, displacing demand in mature sectors.

d. From a cost perspective, Big Tech are more efficient than old service industries but very inefficient compared to the manufacturing sector, given that they haven’t outsourced many of their functions to reduce costs. We should also see rapid pressure to reduce costs from suppliers.

e. Big Tech and larger Unicorns typically have oligopolistic power thanks to their information network data management.

2. “Behaviorals”

a. Memory of recent large losses in the stock market fade at a rapid rate for the believers. In addition, a dearth of trends in equities means that momentum strategies easily latch on to a narrative and price action that has some persistence.

b. Megacap Tech and structural forces such as Green Tech inspire confidence. One should refer to such companies as Blue Chips (well established, stable and well recognized company). Their leaders such as Elon Musk offer thought leadership that often affects the entire Tech industries as they are willing to take new breakthrough risks.

c. Tech relies on a pool of belief not only among retail and professional investors but – particularly importantly for Unicorns – with Venture Capitalists. Such pools are more easily found in the West Coast of the United States than in Europe, but increasingly so here.

3. The need for innovation should accelerate amid subdued long-term growth

a. Key megatrends should favor the Tech industry namely rising automation, AIs, Green and disruption technologies.

b. The transformation of the old economy into a new one, a more Green one, should accelerate. Low productivity suggests that there is ample scope for growth especially through new generations of AIs in the service industries.

c. Innovation tree: The bigger you are or the more funding a sector gets, the greater the portfolio of projects including low probability but high potential ones. Failing that, you can acquire new promising technologies.

4. Valuations are becoming appealing

a. Unicorns are much cheaper than they used to be (e.g. ARK innovation) as earnings expectations become more realistic. As a result, the ratio of US Growth to Value stocks is far lower (see Graph next page). In a slowdown, Big Tech growth does typically better and would be helped by less tight monetary policy.

b. Big Tech remains generally somewhat expensive versus short-term metrics (forward PE) but far more expensive if we consider the long-term.

Source: Nordea Investment Funds S.A. and Bloomberg

What does it mean?

This thesis suggests some selective interest in Tech particularly combined with Value along secular factors (e.g. Green transformation). Indeed, we maintain our view of a preference towards a mixture of Tech and Quality found in some Big Tech & Green energy. Over time, as inflation eventually peaks, demand/investments should recover with a lag and with it most investment styles.

 

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