Is there enough digital wind to power the markets?

Technology shares were a major driver of market returns during the Covid-19 pandemic, but there have been some sharp falls so far this year. Is this a temporary blip?

| 7 min read

The great bull market of the last decade has owed much to the digital revolution. People’s lives have been transformed and businesses changed substantially by the advent of so much more computing power in hand-held smartphones, in ubiquitous computer tablets and in more-widespread laptops.

Before Covid-19 emerged, online retail was gouging the trade of many a physical shop chain; alternative media was nibbling away at the dominant share of the traditional channels; online advertising was eroding newspaper and tv adverts; and online booking and banking were gaining more followers.

Markets became enthusiastic about these great agents of change – the large tech companies with the resources and the hunger to take on traditional business and place large bets on people’s future conduct. Google was there with a near-monopoly on search information giving it scope to charge for more adverts.

Mega-cap winners

Microsoft was the main supplier of the world’s increasingly-sophisticated software packages to power all the devices we need to enjoy the digital revolution. Apple became the darling of the consumer market with its stylish devices and presentations, creating a dominant standard for smartphones and pads.

Amazon enjoyed years of aggressive growth of turnover without much worry over profits.

Amazon defied gravity in the hotly contested retail space, enjoying years of aggressive growth of turnover without much worry over profits. It emerged as the dominant online player with a capacity to generate huge sums in cash from willing customers, buttressed further by drawing income from Prime subscribers prepare to pay a regular fee for various benefits on delivery costs and wider services.

Netflix in the streamed entertainment space had a good run, offering subscribers access to a popular library of films to view. It did not establish the same dominance as the big four, and face substantial competition from Disney, Apple, Amazon and conventional media companies which have entered a competitive field to acquire talent and new film products, and to woo subscribers.

Chart 1: Netflix net user growth by quarter

Facebook was an early developer of a popular social-media model, but that too encountered more competition. The social-media groups came up against more regulatory pressures earlier in their development, as governments worry about free-speech models which give facilities to terrorists, criminal businesses, and users of abusive language.

China’s rival systems

These developments in the West were paralleled by comparable advances in China. China doubtless borrowed, bought or acquired some important ideas and intellectual property from the US, but soon established itself as having a capability to augment and adapt the digital technologies to its own social system.

The Chinese government liked the information it gave them about every Chinese citizen.

China pressed on with fast adoption, with Chinese consumers liking the convenience of computer-based ordering and paying and the Chinese government liking the information it gave them about every Chinese citizen. The deal was that the citizen would get richer and have more digital control over their lives, whilst the state would have more ability to nudge or control their conduct in the name of public safety.

The pandemic took these well-developed trends and put them on accelerants. Netflix put on millions of extra subscribers. Amazon orders took off as shops closed. Laptop deliveries surged from 160 million in 2019 to 240 million in 2021. US smartphone ownership reached 85% of all Americans, up from 35% ten years earlier.

Suddenly, almost everyone needed a smartphone or tablet to order goods online, to download entertainment, to stay in touch with friends and to work from home. As most people in advanced countries had to spend weeks locked down at home, the digital option was the only one for everything beyond the basics.

People who had been reluctant to take up the new technology or who were unable to work it had to take to the internet with the rest and found tech-savvy employers or relatives and friends to instruct them remotely in the dark arts of digital life. Businesses needed to expand and adapt their office technology capabilities to handle all online or the hybrid meetings that followed. Several years growth in digital was compressed into the months of Covid-19.

Chart 2: Laptop sales and smartphone adoption in the US

Will growth continue?

In equity markets, investors naturally turned to increase their holdings in the super winners from lockdown, at a time when questions of survival hung over some companies in all the banned areas of economic life from eating out to staying in hotels to travelling by boat or plane.

Markets have been marking down and selling off many of these once-glamorous shares.

This year, the mood changed sharply – despite continuing good turnover and profits growth from most of these digital giants. Markets have been marking down and selling off many of these once-glamorous shares. They do so because inflation stalks the world, bringing higher interest rates, tighter money and lower asset values generally.

The markets are trying to distinguish between three groups of technology success stories. There are those that had a dramatic boost from lockdown which will wane now more normal life resumes. Demand disappointments allied to more competitive conditions, as in the downloaded entertainment space, can mean bad news for equity prices.

There are those with big wins from lockdown which will manage slower growth that still beats GDP growth and permits continuing good progress on profits. The shares may fluctuate for a bit and then resume their upward journey. Only those that can bank their super growth of the last two years and show they still have a special business proposition that allows continuing fast growth will defy the storm. They are likely to be those with strong market positions and continuing pricing power.

Chart 3: Information Technology and Communication Services weights in S&P 500

Meanwhile, the digital cold war is well advanced. The Chinese will continue to develop their own systems and seek to sell them to the part of the world that looks to them for leadership. The US will call on its allies to circle the waggons of western technology and help the US keep ahead. There will be more protection as part of the policy background.

The threats from President Joe Biden to break US alleged monopolies or undue market power by the giants of the US industry have abated. Maybe he has other more difficult distractions with Ukraine, Taiwan, the long-delayed budget and the voting laws. Maybe he is realising that picking a fight with successful domestic businesses with plenty of jobs in Democrat states would be none too smart. This reduces one of the worries some analysts have held with the digital giants. It leaves us with a need to watch margins and profit-growth rates.

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Is there enough digital wind to power the markets?

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