By Daniel Shvartsman
The tech sector has led the market for much of the past decade, and the pandemic environment only accelerated that trend. 2021, however, put a slight crimp in that pattern. As of market close December 28th, the Nasdaq (23.2%) trailed the S&P 500 Index (29.2%) and was about slightly ahead of the Dow Jones Industrial Average (21.1%) on a total return basis year to date. The Nasdaq will finish comfortably in the double-digits return range, with the year-end rally pushing it over the 20% mark, but that is still a come-down from 45% total return in 2020, more than twice its peer indices. Underneath the surface, the action in the tech sector has been a lot more volatile, as early year speculation in SPACs and newly public companies gave way to selling off “pandemic winners”, as their forward growth looks much foggier.
As the end-of-the-year period has made clear, we’re entering a different environment, one of inflation and potential rate hikes on the one hand, and of continued pandemic-related twists on the other hand, including even the possibility that (one can hope) it has finally faded to being a background issue. The immediate and secondary effects on tech, from consumer spending to supply chain snarl to continued software adoption, will be hard to avoid, but also hard to predict.
Here are five things to watch for in tech in 2022. All figures as of market close December 28th.
1. Are Semiconductors No Longer Cyclical?
If 2020 saw software players lead the sector, 2021 has been all about the semiconductors. Nvidia (NASDAQ:NVDA) more than doubled, becoming the highest valued semiconductor maker in the world, while the iShares Semiconductor ETF (NASDAQ:SOXX) rose 45% for the year. Challenges to the supply chain, designed for maximum efficiency rather than redundancy, have caused logjams in phone production, car production, and just about everything that uses a chip in between.
High demand - driven by increased electronification of cars, the internet of things, artificial intelligence, and computing devices and power in general - combined with supply constraints suggest the boom can stretch out. “Longer-term secular trends are driving the semiconductor and wafer fab equipment markets structurally higher,” is how leading semiconductor equipment provider Applied Materials' (NASDAQ:AMAT) CEO Gary Dickerson put it. Semiconductors have been notoriously cyclical in the past, so the question is whether the increased capacity leads to an overbuild environment or is just enough to keep up with demand; if it’s the latter, semiconductors could continue to soar.
2. The Software Slowdown - A New Normal?
Software players were among the hardest hit in 2021, as the enormous pandemic-fueled growth rates they posted a year ago couldn’t be sustained. Zoom (NASDAQ:ZM) continued to beat and raise this year, but especially slowing billings growth foretold a less exciting future, and the stock dropped 45% for the year and 59% from highs. That’s just the headline example, and while there are stocks which bucked the trend, many of the top software sector performers are SaaS 1.0 names like Oracle (NYSE:ORCL) or Teradata (NYSE:TDC).
2022 and the outlook for 2023 should give investors clarity on whether a new normal will entail re-accelerating growth, or whether expectations need to be reset after the boom times of the early pandemic. Within the scope of higher interest rates and perhaps a renewed focus on profitability, the pressure on the sector may only increase.
3. Whither The Attention Economy?
Social media was another sector to struggle in 2021, and several new media peers fell along with it. Pinterest (NYSE:PINS) and Roku (NASDAQ:ROKU) typified the pullback in these two industries with more than 30% drops for the year and more than 50% drops from highs, but it spread more widely to names like Spotify (NYSE:SPOT), Twitter (NYSE:TWTR), and even Snap (NYSE:SNAP).
At the same time, the longer-term secular trends - advertising dollars and content subscription dollars moving online - are unchanged. Moves like AT&T's (NYSE:T) spin-off of Warner Media to merge with Discovery (NASDAQ:DISCA) suggest the importance of scale in the media industry, and the report of PayPal Holdings Inc (NASDAQ:PYPL) (unconsummated) interest in Pinterest is just an example of the potential consolidation/strategic value in companies that capture consumers’ attention. So the question is where users’ attention goes, and whose investors benefit from it.
4. Continued FAANMG Dominance
Market performance as a whole was reliant on the biggest companies in the world leading the way. Alphabet (NASDAQ:GOOGL) and Microsoft (NASDAQ:MSFT) were head of the pack, but Apple (NASDAQ:AAPL), Meta Platforms (a.k.a. Facebook (NASDAQ:FB)), Netflix (NASDAQ:NFLX), and Amazon (NASDAQ:AMZN) all finished in the green this year, with the latter two being the only ones to trail the wider indices. They have shrugged off antitrust scrutiny and the challenges of size by continuing to post impressive profit and revenue growth numbers, and generally outperformed their industries. And for all that, there’s an argument at least in some cases that the valuation is not crazy, whether it’s Meta’s 25x EV/free cash flow multiple or Alphabet’s 27.75x multiple. As more rate-sensitive names get hit, FAANMG will be on watch as the flight-to-safety play.
5. M&A Revival
A changing and slowing environment might be the spur for increased acquisitions in the tech sector. While 2020 saw Salesforce (NYSE:CRM) take out Slack and AMD (NASDAQ:AMD) buy Xilinx (NASDAQ:XLNX), 2021 was slower. Microsoft bought Nuance Communications Inc (NASDAQ:NUAN), and several data-center-related deals went through, but 2021 tech M&A was more about deals that didn’t happen: Zoom dropping its bid for Five9 (NASDAQ:FIVN), Pinterest/Paypal talks not coming to fruition, and most notably, continued scrutiny for Nvidia’s planned takeover of Arm Holdings.
While antitrust concerns might stay the buying habits of some of the giants, a slower growth and still low rate environment could lead to renewed M&A action. This could come in sectors with abundant competition like software or media, especially. With news in the last weeks of 2021 of Oracle buying Cerner (NASDAQ:CERN), the starting gun for tech M&A in 2022 may have been fired.
Read also: Can Chinese Stocks Rebound In 2022?
See our full outlook series here.