As tech chiefs prepare to discuss their companies’ prospects on earnings calls in the coming weeks, they could do worse than study how their counterpart at Microsoft, Satya Nadella, just handled the matter.
Announcing plans this week to cut around 10,000 jobs, Nadella struck what has become the accepted tone of cautious optimism. The pandemic boom in tech spending has passed.
Globally, there may not be a broad-based recession yet, but customers are acting as though one might be coming. It is time to trim short-term investment plans and close down marginal projects that should have been scrapped a while ago — but not take the foot off the gas completely because the seeds of the next tech boom are already being sown.
After a savage stock market re-rating for tech stocks in 2022, the sector earnings season that is about to start will be important in setting expectations for 2023. As much as the actual figures, investors will be peering through the fog of uncertainty and worsening customer sentiment for clues about whether a bottom for this year could be in sight.
The final months of last year provided plenty of evidence of how tech markets had started to turn down after a period of heavy spending. A hardware contraction started with purchases of PCs, always the easiest to delay, but spread more broadly late in the year. A sharp downturn in chips, as a sudden inventory correction hit a sector that had been plagued by supply shortages, showed signs of deepening. Advertising and ecommerce demand started to weaken as inflation and higher interest rates bit. Even growth in cloud computing, one of the big growth markets, took a step down as customers took a closer look at their soaring cloud bills and decided to economise.
As the latest numbers are studied for signs of whether trends like these have worsened, two questions above all will dominate this earnings season. How resilient will the biggest tech companies be in the face of a what, for now, still looks like a relatively modest economic slowdown? And are parts of the tech sector already at the low point in the cycle, setting things up for a rebound later in the year?
The partial unwinding of Big Tech’s lofty valuation premium was one of the big stock market stories of last year. The story of 2023, by contrast, will be the continuing unwinding of the pandemic tech spending boom. Revenue growth for the biggest companies (Alphabet, Amazon, Apple, Meta and Microsoft) is expected to slow to 7 per cent per cent this year, down from 29 per cent two years before.
In the face of such a slowdown — and after a recruiting spurt that went on well into last year — recent job cuts across the sector look like a prudent first step, although it is too early to tell if they will be enough. The reassuring message from Big Tech has not been lost on Wall Street: The companies will do what is needed to protect margins as they look to their scale, geographic and business diversity and entrenched business models to ride out a downturn.
Microsoft is a case in point. Its dependence on the PC market once left it heavily exposed to tech spending cycles, and it is still expected to see growth slow to as little as 2 per cent when it reports earnings next week. But the shift in its business to subscription income and pay-for-use cloud services has ironed out some of the bumps, and a greater reliance on large customers has made its business more stable.
Many analysts are hoping that other big tech companies will show similar resilience, even in markets that could be most exposed to economic contraction like online advertising and selling expensive gadgets to consumers. Those hopes have prevented a steeper downturn in the stocks of companies like Alphabet and Apple, although it has also left them vulnerable to disappointment this earnings season.
As the worsening news in the chip industry late last year showed, it is still too early to call a bottom. But the prospect that interest rates and inflation have peaked, and China is reopening after the pandemic, have stirred hopes of a coming rebound.
The Philadelphia index of semiconductor stocks has risen 30 per cent from its low point three months ago. It is too early to tell whether this is merely a bear market rally or a sign that better times are coming. But as they gauge the extent of the downturn in their markets in the first half of the year, how many tech chief executives will be ready to start talking of a potential second-half recovery?