Torsten Asmus
U.S. tech stocks have rallied more than 20% this year. But investor enthusiasm may be put to the test if the upcoming earnings season proves to be gloomy. Greg Bonnell speaks with Jim Kelleher, Director of Research at Argus Research about the outlook for the tech sector.
Greg Bonnell: While many investors have been focused on rising rates and the risk of a recession, the first three months of this year saw the tech-heavy NASDAQ index notch its best quarter since 2020. So what’s driving this recent performance, and where might it head from here? Here to discuss, Jim Kelleher, Director of Research at Argus Research. Jim, great to have you back on the show.
Jim Kelleher: Good afternoon, Greg. And thank you for having me.
Greg Bonnell: All right, Jim, so after a pretty rough 2022 across a lot of asset classes, including tech, quite a first-quarter performance for some of these names. And what was happening there?
Jim Kelleher: Well, going back to 2022, if you recall, the tech sector declined about 20% within the NASDAQ decline. And actually, earnings were holding up well. Companies were still building their backlogs. And they performed well.
Now you get to 2023 in the first quarter, earnings were down, as reported in January, for the fourth quarter. And they’ll be down again in the first quarter, as reported in April and May. And yet the tech sector is up over 20% year to date. And I guess the way we explain that is that the market is anticipatory.
Investors already have digested all the bad news in the market, including the inflation-driven weakness in consumer devices like PCs and smartphones. And they are — they’re skating to the puck, right? They expect the market to get better as we go along. And there already are a few hopeful signs out there. But we definitely have some weakness in the near term in terms of fundamentals. And at the same time, we have a positive stock environment.
Greg Bonnell: Let’s talk about that near term then. Because of course, we have another earnings season right on our doorstep. At some point, we’re going to be hearing from the tech companies. You said there briefly that you expect, perhaps, another tough quarter for some of these names. What should we be bracing for?
Jim Kelleher: Well, I think the tech sector will have negative earnings in this quarter within an overall negative earnings quarter for the S&P 500 here in the US. And certain areas like semiconductors should be particularly weak. Other areas like enterprise software and communications equipment will do a little better.
But we’re still going through this digestion phase. We had this hyper-growth phase in smartphones and PCs in the wake of the pandemic. And the supply chain crisis caused companies to overload their inventories, double-ordering in many cases. And so the distribution chain got very clogged. And now that’s all working itself out.
We do expect PC sales to swing back to something closer to more positive year over year. But the comparisons will be easier. But it’s going to take a while. We saw a very weak first quarter PC sales, down over 29%, which was similar to what occurred in the fourth quarter, global PC unit sales down in the high 20% range for two straight quarters.
Greg Bonnell: IDC with its latest report today and talking about that slump that they’re seeing in PC demand, obviously, there’s a certain cyclicality to it, and things got out of whack during the pandemic. In my household, everyone– OK, including me, I was going to exclude myself, everyone, including me, got a new computer. So we’re not going to buy one for a little while. How does that cycle play out coming out of the pandemic?
Jim Kelleher: Well, we’re still seeing a filtering back to offices. So there’s still an overdue upgrade cycle for enterprise and business PC refresh. But that’s being pushed out a little bit because the return to office has been kind of mixed to slow. And people did — initially, everybody was kind of bootstrapping. In 2020, whatever you had on hand, you made do with.
2021 and early 2022 were the years in which you upgraded your hybrid home-work environment. And so everyone is sitting in a pretty good– a better position there. But those products will need upgrade too because the demands of the modern workspace just keep going up. And every software upgrade puts more strain on your existing PC and device.
And also, we see other factors, growth in the global middle class. So maybe the best growth in PCs is not going to be North American-based. It’ll probably be Asian, South American-based. But we do see the cycle playing through, as it always does.
Greg Bonnell: We started off with talking about what a strong quarter the NASDAQ had, the best quarterly performance since the early days of the pandemic, that first year of the pandemic. But as I take a look at the chart, we’re still well off of the highs. I know some people who’ve been watching the show were thinking, OK, it was one thing to see that rally after the losses for the sector. But if they’re in the positions where they’re wondering, do we ever get back to where we were, I mean, what would that take? What would the market have to look like for — to reclaim those highs?
Jim Kelleher: Well, for the market overall, first of all, you’re going to need to get out of this cycle of rising rates. You need to have a global stabilization in rates. Markets can handle a higher level of rates. What they can’t handle is movement in rates. And once we get to a steadying in rates, that probably means we’ve got to a steadying and a lower level of inflation. Inflation is the one thing stock markets cannot handle.
But I think when we come out — I’m going to speak from a technology perspective now. We’re seeing a traditional cycle here where PCs and smartphones are driving the weakness in the tech sector. And that’s what always happens. But there are so many more drivers in technology now. I mean, tech companies used to sell to one another. Now they sell to the world. And we’ve seen technology, sensors, automation, electrification of vehicles, semi-autonomous and autonomous driving. All these things are driving great demand for technology components, semiconductors, software outside the traditional tech industry.
And so coupled with AI and the cloud, we’re going to see — as we get the traditional drivers to recover — that is, PCs and smartphones — and those other parts of the market to take off, the tech sector is going to get bigger than it ever was. And the demand should come back in another strong cycle coming out of this. Timing is the question.
Greg Bonnell: Yeah, the argument that does make a lot of sense, Jim, is the fact that even though you’re going through a cycle right now, we’re seeing weakness in certain areas, technology is not going anywhere. I mean, longer-term, if an investor is looking at the longer horizon, it’s not like we’re just going to turn around and say, I don’t think we need all this technology anymore. Thanks. We’ll just go back to where we were.
Jim Kelleher: Right. I do also think that the tech sell-offs, the cycles are shorter and shallower. Because although we did see a hyper-growth phase in PCs and smartphones — and the harder we came, the harder we fell, right? But the demand for, for example, industrial and automotive semiconductors is really smoothing the semiconductor cycle out and taking out some of that cyclical lumpiness. And there are certain names we’ll talk about later that we think are really well-positioned to serve those markets.
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