Well, the good news is that the first half of this year is over. We just went through the worst six months in the S&P that we’ve seen since 1970.
Fun fact: here are some things that weren’t invented in in the 1970s:
- The internet,
- Mobile phones,
- Post-it Notes,
- The Rubik’s Cube,
- MRI machines,
- Walkmans, and
- Floppy disks.
So, yeah, it’s been a while since markets have been beat up this badly.
The market hasn’t been kind to tech stocks
Trying to navigate the inflationary pressures of excessive government stimulus and supply chains that still have not fully come back online, many investors have moved away from growth equities. Rising interest rates—put in place to try and control rampant inflation— have only reinforced these sentiments. Add in the current geopolitical turmoil going on in Ukraine that has spiked many commodity prices, and what you have is a perfect storm for people moving away from riskier assets.
As of July 21, 2022, the NASDAQ was down 12%, the S&P 500 down 9.5%, and the TSX was down 8% over the last six months. The median multiple of the high growth software basket was on a runaway train trading up near 35x EV/Revenue. That number is now 8x. That's 27 turns of multiple compression! It’s been kind of gnarly, and not in the way surfers use that word. (1)
Here’s how we are thinking about growth
This macro backdrop has left many people uttering the dreaded “R” word (recession) in hushed circles.
But it’s not all doom and gloom, and it doesn’t necessarily have to go that way. Commodity prices are turning a corner. Oil, soy, wheat, and corn prices have all sharply declined. If prices continue to fall or level off in key sectors, it should give risk-on assets permission to rally as the Fed eases the deflationary pressure it is putting on the economy.
So, what does this mean for tech?
While many e-commerce platforms could find it very difficult to recapture their spectacular pandemic-inspired growth, fundamentals are still strong in a lot of companies focusing on cloud-native infrastructure software. Yes, multiple compression has been the name of the game over the last few months. However, we believe that we have seen the worst of it for many software companies.
Our belief is that mission-critical cloud-based applications have become fundamental to how people do business. Because of this, we tend to think they will be much more resilient to economic downturns as compared with other growth stocks. Of course, revenue growth for these companies may slow if there is a general cooling off of the market, but a large component of their costs are variable. This allows for the more mature companies to maintain free-cash-flow margins.
The last few months have been rough on tech stocks. However, fundamentals remain strong in many companies that focus on cloud-based software. The pandemic has entrenched a widespread reliance on these providers that will likely result in continued growth in the sector.
Remember—software is one of the only categories that is anti-inflationary, as it increases the productivity of the average worker. In this tight labour market... we need all the help we can get. Software budgets will be the last to be cut.
—Nick Mersch, Portfolio Manager
- “Stock market and sector performance,” Fidelity: https://eresearch.fidelity.com/eresearch/goto/markets_sectors/landing.jhtml
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