Technology providers would benefit from recession

The technology sector is sensitive to interest rate movements given its higher-than-average growth profile and longer duration of cash flows. To combat inflation, other central banks embarked upon aggressive rate hikes last year, which we believe were the primary driver of the 35% drawdown in the Nasdaq from the November 2021 peak, to the end of 2022. Inflation is now down from its peak in September, and we believe a moderating economy could support a further decline in inflation. Consequently, technology sector valuations have stabilized in recent weeks. While we cannot predict how central banks will respond in the coming months, we think it is likely that we are nearing the end of rate hikes, which would be a positive for growth technology equities. 

With the potential for calming rates, investor focus is transitioning toward the likelihood of a recession in 2023. As technology investors, we would view a recession as a positive as it would likely require central banks to at least stop increasing, and potentially even decrease, rates. While we are not assuming this outcome, we estimate that a 100-basis point decrease in the risk-free rate would increase the terminal multiple of the technology index by +20%. Additionally, a recessionary environment would highlight the technology sector’s relative strengths. First, the world’s largest technology companies have strong balance sheets with net cash positions. Unlike net debt companies in other sectors, well capitalized technologies companies will not need to raise expensive debt to sustain operations. It also puts technology leaders in a position to win share from smaller undercapitalized competitors and or acquire them at attractive valuations, further strengthening their positions. Second, enterprises invest in technology, most notably in software, to drive improved productivity, which is more critical in a downturn. Of course, there are more cyclical areas within technology which could struggle as consumer spending declines, such as PCs/mobile phones, eCommerce, and digital advertising. Many stocks in these sub-sectors have already begun to discount weakness, creating attractive valuations for investors with a longer time horizon. Looking beyond the risks of a near-term recession, we believe digital transformation will remain a powerful secular growth driver for the sector and the 10 sub-themes we have identified for many years to come. This, combined with improved valuations and the possibility of a more favorable interest rate environment, we believe creates opportunities for investors in 2023 and beyond.