If we were to sum up the year, we would be tempted to borrow from Elizabeth II her formula used just thirty years ago. 2022 is an “annus horribilis” for growth stocks and American Tech. War, energy crisis and Sino-American tensions call into question 30 years of globalization against a backdrop of inflation, rising interest rates and recession. 2022 also marks a break from 10 years of outperformance by technology and internet stocks. The hype for metaverse and cryptos has given way to doubt. The parallel with the bursting of the internet bubble is tempting, as the latter has also succeeded with 10 years of out-competing technology. Would history just repeat itself?
So what really happened in the last 10 years?
Let’s go back to the summer of 2011 with Marc Andreessen’s famous phrase “Software is eating the world”, which predicted what followed. Companies thought and developed on the vision that software should be placed at the heart of the strategy and not used as a simple tool, have “disrupted” parts of the economy and revolutionized the way we live, communicate, sell and work… Apple based its strategy on IOS, Amazon and Netflix have eroded the distribution of goods and content, Google and Facebook are doing the same on advertising… with identical revenues: a large-scale effect achieved at a very low marginal cost. Software has transcended borders and its market is global, leveraging new communication infrastructures, information highways (fiber/4G, etc.) to reach billions of customers. The cloud enabled scaling and semiconductors provided computing power.
These highways all lead to Silicon Valley, whose reign began some 50 years ago with the first transistors and whose technological and economic hegemony resembles that of the Roman Empire. On the stock market, this is reflected in the overwhelming outperformance of Tech and Internet stocks since 2012.
Has Covid caused a tech bubble?
It is a fact that the pandemic has brutally accelerated the digitization of the world and helped to preserve its continuity. In addition to the fact that they offered visibility, Tech benefited from high demand (equipment, collaboration tools, e-commerce) with support from states and central banks. Zero interest rates supported high valuations based on exponential growth prospects, and access to capital was plentiful. During the reopening, traditional businesses tried to adapt to a more digital environment, fueling real demand. The weight of Cloud software has thus doubled and already accounts for 20% of companies’ IT expenses.
One must remember that the race for economies of scale specific to technological disruption involved prioritizing sales growth to outpace the competition (survivors take all). In their quest for market share, companies recruited massively and at exorbitant prices, increasing the number of employees by more than a million employees. The idea that new start-ups could again disrupt the digital giants also gained ground, with unprofitable Tech (1/3 of Russell 2000 companies) gaining more than 200% from February 2020 to February 2021. Shareholders gave their blessing and accepted dilution caused by the massive use of salaries in stocks as long as the market rose… It was also the time of SPACs.
A normalization of pain.
As is often the case, the euphoria only lasts for a while. It was only through competition that it expressed itself. By launching Teams, Microsoft broke the momentum of young startups that, like Zoom, hadn’t really passed the single-product model milestone, reminding us of the power of large platforms and their bundled offerings.
Not everyone deserves to be valued at 20 times sales, especially when central banks tighten their monetary policy. Additionally, if Covid has accelerated the changes already under way, it has also shown the limits of all telecommuting, as Tech bosses are the first to recognise.
Is the economic situation affecting Tech more? Bill McDermot (head of Service Now, leader in automation of IT and HR tasks) claimed this spring that Software was one of the most powerful deflationary forces in the world, promoting its solutions to achieve productivity and limit inflationary wages.
Behind this serious argument there is also a reality, technology is less sensitive to rates, companies are less indebted. However, the economic slowdown is causing some customers to prefer cutting immediate expenses over later productivity gains. Due to their real weight in the economy, some technologies, like GAFAM, are more sensitive to economic conditions (Alphabet and Meta account for more than 80% of advertising). Newer models have not been tested under difficult economic conditions. As a result, the slowdown in growth means monitoring margins and reversing cost structures, hence the 100,000 announced layoffs.
Is the era of AI and the Metaverse compromised?
These notions often cause confusion, the fields being as vast as they are vague. The virtual world needs artificial intelligence technologies and they are based on the same foundations that have made the growth of software: efficient and latency-free infrastructures (5G), access to mass data (Cloud) and semiconductors, more powerful and personal . The US administration has understood the challenge of maintaining technological dominance and is doing everything to prevent the second empire, that of the Middle, from catching up with Silicon Valley. Meta’s latest setback in its project to merge a new ecosystem fuels the rhetoric of a bubble by associating it with cryptos. There are common reasons for the bubble of the 2000s: incomplete infrastructure, offers that have not yet found their demand and, as a result, too many expenses and not enough income. This is all the more damaging to an advertising model weakened by the economic situation, competition and regulations. In the end, it doesn’t matter if the vision is right.
This incident should not make us lose sight of the fact that artificial intelligence and certain forms of the metaverse are already at work, transforming sectors so far less affected by digitization, such as industry, health or energy. Transport and factories are gradually being controlled by continuous software applications. Robotics is able to produce, anticipate and adapt. Like electrification in its time, automation represents a paradigm shift for models weakened by the globalization of production chains. Andreessen’s prediction remains relevant in the sense that companies that place AI at the heart of their strategy and not as a simple tool will revolutionize parts of the economy, disrupt industrial and energy balance, contribute to reindustrialization and progress.
This era will require more continuous innovation, investment and specialization, which will benefit semiconductors and infrastructure providers. Digital transformation will continue throughout the decade, with cloud software likely to rise from 20% to 70% of enterprise IT spending. However, in an environment with less abundant capital, we believe that it is not so much the companies that grow the fastest, but rather the leaders who already have resources and generate cash flow that will come out on top. They will have an advantage in investing in R&D and can afford to buy innovative competitors.