Investing in tech stocks after the big blowout

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By Lei Qiu

Technology stocks have been hit hard this year, leading some investors to question the future of the sector. But despite the downturn, we believe technological innovation is entering a new phase in several areas awaiting strong growth.

investors in technology stocks were heavily cheated. Technology stocks in the MSCI World Index have plummeted nearly 33% in local currency terms this year through Sept. 30. In the US, the tech-heavy Nasdaq Composite Index fell by a similar amount, while unprofitable tech stocks suffered even heavier losses. After several years of steady gains, investors face a reckoning. Is this year a correction to bring stock valuations in line with realistic corporate earnings? Or does it reflect a sharp slowdown in a sector that has matured following pandemic-accelerated consumer use of technology? Maybe there just isn’t much growth left.

Questions like these are inevitable, but miss the point. In fact, the technology market is changing, innovation is spreading and new areas of leadership are emerging. Investors looking for growth in the right places can find exciting opportunities.

What has changed on the innovation curve?

Over the past two decades, innovation has been driven by the spread of broadband and mobility. Since the launch of the iPhone in 2007, billions of people around the world have taken advantage of newfound ways to surf, shop and play on their mobile devices. This has led to massive growth of companies driving mobile ecosystems, including network providers, chipmakers, and phone manufacturers.

The giants of technology and new media enjoyed explosive growth. Facebook, Apple, Amazon, Netflix, and Google came to be known as the FAANGs, a group of highly profitable mega-cap stocks that seemed unstoppable up until this year.

Some of these markets are mature (advertisement). For example, global smartphone penetration has surpassed 100% and shipments are slowing. The rapid growth of social media could also be at its peak. Of course, in the heart of the last digital decade, companies are still likely to see growth. But they’ve become like utilities — companies that provide essential services and may have reached maximum profitability.

Consumer Technology as a New Utility: Signs of Maturity

Annual smartphone shipments/time spent on social media (US)

The analysis is for illustrative purposes only and may be revised. *Calculation takes into account total number of users on each social media service and minutes per user in each quarter. As of June 30, 2022. Source: Sensor Tower and AllianceBernstein (AB)

What’s next? Technology-enabled infrastructure transformation

But technology is not dead. On the contrary, innovation is driving the transformation of technology-enabled infrastructure, which has become a necessity due to changing consumer behavior. Any business that wants to survive and thrive in a digital world must strategically approach its technology infrastructure. As a result, we believe demand for advanced infrastructure technology will continue even in a gloomy economic environment.

Because the future of society lies in digital technology. In the post-pandemic new normal, companies must ensure the flexibility and efficiency of their workforce. To do this, they must quickly move workloads to the cloud using business applications and data management tools (advertisement). This requires more spending on cloud infrastructure to ensure faster and more reliable processing and response, as well as cybersecurity tools to protect the virtual work environment.

Beginning of the next phase of growth: Transformation of the technology-enabled infrastructure

Global Public Cloud Revenue by Segment/Global Digital Workload by Segment: Total Spend

The analysis is for illustrative purposes only and may be revised. *Based on International Data Corporation (IDC) Worldwide Semiannual Public Cloud Services Tracker, May 2021. †PaaS is a platform as a service. IaaS is Infrastructure as a Service. As of June 30, 2022. Source: IDC, Jeffries and AB

Inflation is another driver of technology spending as companies face cost pressures from labor and resource shortages. Businesses around the world are examining supply chain vulnerabilities, seeking to onboard more operations and achieving energy independence amid the changing geopolitical landscape. Technological innovations can alleviate cost deflation in many ways.

Where are the next big opportunities?

Different types of businesses require different technological solutions. However, some clear trends are already emerging.

Robotics is on the rise (advertisement). This is not only happening in the auto and electronics industries, which were among the early adopters. From healthcare to agriculture to retail and logistics, companies are discovering that robotics can enable efficiency gains and cost savings with faster and more impressive computing power than ever before and artificial intelligence capabilities to make decisions that mimic human decisions.

Robots and the Internet of Things are driving the wave of innovation

PC and Mobile vs. IoT/Industrial Robot Deliveries

The analysis is for illustrative purposes only and may be revised. As of June 30, 2022. Source: International Federation of Robots and AB

Humans and machines also communicate in new ways via the Internet of Things. Intelligent, cost-effective sensors enable all machines, cash registers and products to be networked and are redesigning communication between people and machines – and between machines. This is creating an “Internet of Everything” and redefining the future of manufacturing and transportation with huge commercial potential.

Meanwhile, the global drive towards energy independence also depends on technology. Innovations will make solar and wind energy as well as electric vehicles more economical. Energy generation, storage and management all require technological solutions.

What do all these things have in common? First, the new wave of innovation will overcome economic strains as they address growing and enduring needs. Second, the companies that enable technological innovation are still maturing, and in many parts of the market, the leaders are still being defined. Market historians will recall how legends and leaders are constantly being replaced. From the glamorous 1970’s Fifties through the Four Horsemen of the 1990’s (Microsoft, Dell, Cisco and Intel) to the FAANGs, this is a normal process of leadership renewal, particularly in the technology sector.

Investors shouldn’t be put off by this year’s declines in the technology sector. Technology company stocks are now trading at much more attractive valuations than they were a year ago, creating attractive entry points for those with solid business models. It is time to identify the next generation of innovative technology leaders transforming the world’s industrial economies while unlocking strong shareholder return potential.

The views expressed herein do not constitute research, investment advice or trading recommendations and do not necessarily reflect the views of all AB portfolio management teams. Views may change over time.

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Editor’s note: The summary bullet points for this article were selected by Seeking Alpha editors.

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