By Finn Watson

With over $7 trillion dollars sliced off the sector’s market cap this year, massive layoffs, the rise of AI, and a turbulent macroeconomic environment, the next few years for big tech is certainly hazy.

It is no secret that 2022 has not been a good year for markets, but the pain of high interest rates and economic contraction are sharpest in the tech sector whose fiery growth through the pandemic was fueled by a quarantined public and ultra-low rates. Big tech experienced dizzying highs: The NASDAQ composite index – a tech heavy index composed of over 3000 companies – witnessed returns over 40% and 20% in 2020 and 2021 respectively. However, 2022 was a different story as the index dropped over 30%. Such drops from pandemic-era highs are reflected across the entire sector and pull no punches affecting giants such as Meta, Apple, Microsoft, Google and more. Meta dropped over 60% on the year and even as much as 26% in a single day after a poor earnings call. The price of Netflix and NVIDIA halved, PayPal is down 60%, Alphabet and Adobe fell around 40%. Even Apple, a company that tends to be more resilient than other tech equities, had around 1 trillion trimmed off its market cap. This precipitous decline in valuation is significantly more than other areas of the economy. These big tech stocks were among the most attractive investments in 2020 and 2021 but became among the worst in 2022. What happened and why are losses relatively higher in tech than other areas of the market?

Source: Morningstar, Inc. Date as of December 9, 2022

The key to understanding the decline in tech stocks is in how their unique growth focused business model is uniquely affected by the new interest rate environment. Perhaps the defining economic story of 2022 is the Fed’s pivot to higher rates. As recently as the first quarter of 2022, the Fed had maintained an ultra-low 0.25% Federal Funds rate. To combat inflation the Fed has been steadily raising the rate to its current position of 4.5% as of the beginning of 2023. These changes implore investors to reassess the composition of their portfolios, especially for tech stocks tech whose main selling point is the growth of future cash flows. Because the interest rate is used to discount the projected future cash flows, when rates are raised, future earnings are discounted more heavily and the stock value declines. In addition, higher rates mean higher yields on bonds thereby making stocks a relatively less attractive product especially when one considers their respective risks.  Furthermore, higher rates mean higher borrowing costs and less access to financing.

However, at this level of analysis we have ignored the challenges that are specific to tech. After all, the NASDAQ fell an additional 10% when compared to more general indexes such as the S&P 500. Much of this disparity can be attributed to the significant reduction of advertisement revenues, declining foreign revenues due to a strong dollar, and unique strategic vulnerability to rising borrowing costs. 

Spending on ads – a vital revenue source for many tech companies – has declined throughout 2022. In recent earnings calls, Google revealed that YouTube’s advertising revenue dropped 2%. Also, growth in advertising revenue for Google, Pinterest, Snap and other companies is expected to half per a FactSet estimate. The decline in ad revenue growth is largely due to privacy changes as many companies move away from third-party cookies, increased competition from TikTok, and a general decline in consumer spending. Companies such as Google, Meta, and Apple have all embarked on significant changes to their privacy policies which limit the procurement of user data thereby reducing the effectiveness of personalised advertising. In iOS 14, users can now choose to restrict sharing of the IDFA (Identifier for Advertisers) tag which enables tracking and targeted ads. Furthermore, Google is joining Mozilla and Apple in discontinuing the use of third party cookies in their browsers. These moves, while undoubtedly welcome inclusions in a business rife with accusations of privacy abuse, have disrupted the essential advertising revenues. This highlights the continued tensions between promoting shareholder value and improving user experience through addressing privacy concerns. Although advertising revenues are still growing, albeit at significantly slower rates, limited revenue growth paired with higher expenses along with grim guidance have caused earnings calls to be grisly events for shareholders. 

Big tech has also been harmed by the change in US monetary stance and the strong dollar that results by meaningfully reducing the post-exchange revenue from foreign sales. With the Fed raising rates and US treasury yields rising as a result, demand for the dollar is at recent highs causing the US dollar exchange rate to appreciate relative to the currencies of its largest trading partners. The mega-cap tech stocks are particularly exposed to exchange rate risk in this manner because iPhones, PCs, and other sales occurring in foreign countries are purchased using the local currency. When these sales are converted back into the appreciated greenback, the revenue is less than it would have been otherwise. Bloomberg estimates that the strong dollar has reduced corporate revenue by $60 billion in 2022 Q3. 

Although 2022 has certainly been a grim year for tech companies, we have reasons to avoid talk of armageddon and should reserve our comparisons to the dotcom crash. Unlike the dotcom bubble where the internet was completely uncharted ground and many of the big players were solutions in search of problems, the modern tech sector is an established business that has fully entrenched itself in the way society operates. Furthermore, the technology businesses of today are actually profitable and secure because online advertising, social media usage, and iPhone sales, while perhaps slowing down, are unlikely to end anytime soon. In addition, there are many adaptive strategies already being employed: cost cutting, layoffs, new M&A opportunities, as well as new areas of innovation seen in the rise of AI, machine learning, robotics and cybersecurity may all bear new fruits. However, for the future success of these firms, capable management is necessary.

2022 has marked the end of Pax Technologia and these companies must fight to reach their pandemic highs.

The views expressed in this article are the author’s own, and may not reflect the opinions of The St. Andrews Economist.

Photo by Tracy Le Blanc via pexels.com