The tech sector is declining but not about to disappear

The computer, communications and consumer discretionary sectors dominate equity markets, accounting for 43% of US equities and 28% of other markets. They performed very well last year, and a better 2023 will be key. Currently, their earnings outlook leads to weakness as we head into the fourth quarter reporting season, with a double whammy on the horizon: the demand payback for the 2020-2021 Covid boom and a slowdown cycle of discretionary products. But they have defenses. 1) Profit margins are twice the market and often strong balance sheets. 2) Management teams move quickly to cut costs. 3) The sector’s 30% valuation premium to the S&P 500 has disappeared and is supported by falling bond yields. These elements are sufficient to avoid a repeat of the poor performance of 2022 and to support the markets.

Last week, the first live Consumer Electronics Show (CES) took place in two years, with 100,000 attendees and 3,000 exhibitors. CES showcased many tech products that will be released in the coming months (and years). It served as a reminder that behind the decline in demand and cyclical valuations of technologies, innovation is strong. Highlights are specialty products, such as flying and color-changing cars, more affordable smartphones and 13th generation Intel processors, as well as software products, IoT products, AR/ VR and Web 3 applications.

The backdrop remains one of rapid technology adoption (see chart), with a long way to go. This phenomenon has recently been accelerated by 1) an impulse from Covid, through e-commerce, telecommuting, home technology and biotechnology. 2) the venture capital boom, with $75 billion in new global funding in the third quarter. Although down sharply from a peak of $175 billion in the fourth quarter of 2021, this number is up from the $60 billion level reached before the pandemic. 3) Continued cost reductions and capacity increases in enabling technologies, from chips to the cloud.

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