It’s probably not an understatement that 2021 has been a roller-coaster ride for tech investors. A quick glance at the tech-heavy NASDAQ Index reveals how volatile things have been, with the index dipping between 6% ~ 10.5% from highs no less than 4 times!
Nevertheless, it does look like tech stocks will close the year in the green, growing approximately 24% YTD as of writing. This performance slightly lags the broader S&P500 Index that looks to be closing at approximately 27.3% YTD.
As I have alluded to in one of my previous posts, the volatility was to be expected. If you’ve invested in tech, taken a long-term approach and rode out the storm, the results would’ve been pretty decent.
As the new year dawns upon us, what might be the landscape for tech investing in 2022? Here are three of the key themes that I believe might be noteworthy as we traverse the coming year.
1) A Coming Year of COVID Normalization
When the COVID pandemic struck in 2020, pretty much a lot of things turned on its head. We saw huge capital outflows from the market during the initial shock, which gradually returned to the market and into the tech sector in full force and drove a lot of valuations to nosebleed levels. In late 2020, when the vaccine breakthrough was made, the world cheered and looked forward to the “Great Reopening”. This was quickly reflected in early 2021 as capital started cycling away from tech stocks into “beaten down” stocks that were adversely affected by the pandemic.
As it turns out, the “Great Reopening” was less of a big bang and more of a sputter. Recovery efforts around the globe are vastly uneven and have turned out to be more gradual, with many starts and stops along the way (remember the Delta variant?). With each passing day, the dull realization that emergence from the pandemic is less about going back quickly to normalcy but more about reshaping and rebuilding. And this means some of the “old ways” of doing things (i.e., international travel, events etc.) are probably never going to be the same again.
In light of this, 2022 is looking like a year of continued normalization as we resolve to find a work-around and move on with our lives with less fear of the pandemic and less expectation that things will go back to the way they were. In many ways, it’s a year of coming to terms with a new reality.
2) The Battle Against Inflation and Rising Interest Rates
Concerted efforts of various governments worldwide to ease monetary policy and provide support have, by and large, kept many folks afloat during the pandemic-driven economic crisis. As economic recovery started to take place in 2021, consumer spending also resumed.
Unfortunately, this seems to have an unintended consequence. As sectors that were heavily impacted by the pandemic were rebuilding, the pace of consumer demand, aided by government-backed liquidity, has far outstripped supply capacity and has led to inflation across the board. In the US, the Consumer Price Index for November 2021 has risen by 6.8%, the highest pace of increase since 1982!
As we enter 2022, it does not look like inflationary pressures will ease as this is something largely driven by pandemic induced supply shocks. To reiterate, the process of redefining and rebuilding is going to take time. It does look like there aren’t many arrows left in the quiver of various Central Banks around the world except to tighten monetary policies. In the latest announcement by the US Federal Reserve, the majority of the committee members foresee at least 3 interest hikes in 2022.
But my observation is that in spite of the anticipated rate hikes in 2022, the overall rates in question are still rather low, with most targeting rates below 1%.
3) The Evolving Role of Digitalization
When the pandemic first reared its ugly head and nationwide lockdowns were enforced, people and organizations around the world scrambled to find ways to “keep things going” as best as possible. Technology companies became unwitting beneficiaries as an unforeseen wave of demand came crashing upon them.
As the world gradually continues to normalize, the narrative for digitalization is also becoming clearer. It is no longer a scramble to adopt technology as a means to survive, but rather a more deliberate approach to redefine and rebuild purposefully, with rapid digitalization at its core.
There are several factors that continue to drive this for many organizations. The recent labour shortage in several countries like the US, dubbed as the “Great Resignation”, has resulted in several organizations thinking further about leveraging technology to fill productivity gaps. Technology is also an essential tool to enable organizations to attract and retain talent; most of whom are now looking for companies that place importance on factors like remote work arrangements and work-life balance. For organizations that engage in international business or have workers scattered geographically across borders, technology and digitalization are critical. This is considering that the recovery of international travel protocol to pre-pandemic days is still quite far from happening.
How I Plan to Approach Tech Investing in 2022
From the key themes that I have shared above, I’m very much convinced that digitalization and the rapid technology adoption that was brought to a head by the onset of the pandemic in 2020 is here to stay. Considering all this, my attention is turned to the best-in-class tech companies that were able to cope with the sudden surge in demand and take hold of those opportunities.
In my view, these companies’ ability that was proven during the height of the pandemic, puts them in a great place to show continuous sustainable growth and not simply a “pandemic” or “stay-at-home” play. As I have mentioned, there are many reasons to believe that we are still in the early days of this new reality and the road ahead is long.
Having said that, 2022 also brings about some key risks brought about by inflation and its corresponding interest rates. Interest rate hikes could potentially hamper business growth as financing becomes more expensive. This is especially true for the many tech companies that are currently unprofitable and/or burning cash on business growth-related investments.
In an inflationary environment, it is imperative not just to identify the “hottest tech company with great growth opportunities” but also consider the factors of pricing power (to retain customers even if these companies have to charge more), a strong balance sheet and/or cash flows (to have the ability to keep making necessary investments) and exhibit capacity for operating leverage (lower cost needed to generate higher revenues).
From a stock investment perspective, rising interest rates would put pressure on valuation. Unfortunately, many high-flying tech stocks currently have rather extreme valuations. A select few PS Ratio measurements for example:
- Cloudflare Inc. (NYSE: NET) = 70x
- Snowflake Inc. (NYSE: SNOW) = 82x
- Zscaler Inc. (NASDAQ: ZS) = 58x
It’s almost certain that stocks in this class would continue to see extreme stock price volatility in the coming year.
Taking into account all these, I come to two conclusions.
- 1) tech companies are very much still worth the investment
That is, considering the secular trends and how early we are in this journey.
The important thing right now is to tighten the filter and identify those companies that not only have large market opportunities but also have strong business execution and financial resilience.
- 2) but they may be expensive
Secondly, I recognize that the high-quality tech stocks I mentioned are rather expensive at the moment and there seems to be a lot of scope for stock valuation resets, driven by interest rate hikes. At this point, I believe that the projected interest rates by the Fed is rather low to combat inflation and there is definitely room for surprises, with some upward revision. I wouldn’t be shocked if this results in some panic in the markets that may in turn present some excellent buying opportunities. After all, the Fed has been wrong before (remember the “transitory” inflation?).
Therefore, my plan this 2022 is simple.
On the one hand, I won’t be selling any of my high conviction positions, in spite of the currently favourable valuations. On the other hand, I would still look to deploy more capital in 2022 towards stocks of companies that I have a high conviction of (albeit at a slower pace) and keep a larger cash position for opportunistic buys. That way, if I’m wrong and the valuation reset event turns out to be a nothing burger, my currently held positions and continuous investments would benefit from the ride up. If I turn out to be right, I would have some dry powder ready to take advantage of the situation.
In short, it’s capital deployment as usual but with an eye out to manage risks based on information that’s presently available for me to work with. It’s not the time the market, but to play the game.
p.s. If you’re looking to invest in tech stocks with great growth potential in the long run, join Alvin at his free webinar to learn how you can start.
Disclosure: The author owns shares of Cloudflare Inc. (NYSE:NET), Snowflake Inc. (NYSE:SNOW) and Zscaler Inc. (NASDAQ:ZS). Investors should conduct their own due diligence before engaging in any buying/selling of any of the shares mentioned above.