Cloud Tech Players Outperform Semiconductor Stocks, Showing Tech's Dual Nature

 | Sep 09, 2022 11:23

Is the tech sector cyclical or secular? We believe it is both. While technology adoption is clearly a secular trend (a fundamental change in a business model), there are many cyclical trends that impact valuations in the tech sector which vary significantly from company to company. Two major contributors are earnings and interest rates.h2 1. Earnings/h2

Earnings cyclicality is a function of business model and business maturity level. Companies that provide hardware, such as semiconductors face significant cyclicality in earnings as inventory management exacerbates weak demand.

Conversely, software offers solid subscriptions which provide steady earnings. However, depending on business maturity levels, there may be slower growth levels or elongated sales cycles. Similarly, themes and ideas which are in the early adoption stage, such as cloud infrastructure, are less dependent on the economy so their earnings are less cyclical when compared to mature business models such as CRM, e-commerce, and gaming.

h2 2. Interest rates/h2

The risk-free rate is a key valuation metric for all stocks, so the U.S. Federal Reserve's stance on interest rate has driven a lot of volatility in the market, particularly in technology stocks as their valuation is dependent on future profit forecasts.

We estimate that a 1% move in interest rates results in ~15-20% downside in the sector. However, it is important to note that with the 10-year yield between 3% and 3.5%, the current Fed stance on interest rates has largely been priced into stock valuations so tech stocks have been forming valuation floors. We believe that any downside from here will be largely driven by earnings.