Technology company earnings season is in high gear. It is a heck of a time to be a Technology fund PM or Analyst. Despite the NASDAQ Composite being down 13% YTD, the group has another 40% downside or more in our view. Many of the high-multiple of revenue (no earnings) stocks have 80-90% downside as we stated several weeks ago. However, most lower-multiple, cash flow positive, dividend-paying Technology companies will also trade lower from here in our view as the equity markets wrestle with expectations around interest rate hikes, quantitative tightening and price inflation.
The simple math is that higher interest rates mean lower asset values. Higher interest rates will not be sufficient to curb inflation in 2022, but they will have a negative impact on asset values and the real economy. The Fed is tightening (or at least talking about it), at a time when the real economy is starting to slow, which is the perfect way to set the stage for stagflation.
- Higher interest rates will cause companies to think twice about hiring and investing in general. This is especially true given the record levels of corporate debt (approximately $11.4 trillion), much of which will need to be rolled over at higher rates.
- Less debt issuance. Higher interest rates will cause companies to issue less debt and therefore will result in less M&A activity and fewer share repurchase programs.
- Fewer IPOs. Higher interest rates will result in fewer Technology IPOs and IPOs in general.
- First time for everything. Higher interest rates will cause the Technology stock bubble to further deflate – a first-time expereince for many young Technology investors. A prolonged downturn in Technology valuations similar to 2008 will test the mettle of many Technology investors, not only on the public equity side but also as it relates to newbie venture capital and private equity investors.
- Options will exacerbate the pain. We will see an exaggerated pull back in Technology names where Retail investors bought heavily into options as investors sell off those names.
- Fundamentals will eventually matter again once the bloodletting is complete. It is our hope that in the not too distant future investors will get back to fundamental investing and focusing on companies led by high quality senior management teams. Management teams matter. Just ask the employee base at Activision (ATVI).