Technology investors got a big wake-up call in 2022: Tech stocks can go down! Coming off a decade of low interest rates, lots of innovation, and topped off by the pandemic, tech stocks rallied a huge amount over the past decade-plus.
However, coming off the pandemic and with last year's interest rate shock, tech stocks had a massive correction. Many new tech companies that came to market over the past few years plunged 70% or more, and even profitable blue-chip Microsoft (MSFT 1.65%) fell 28% last year, including dividends.
After Microsoft's December quarter-earnings report, the stock initially fell as investors saw the company's overall growth rate drop to 2% and management guiding for a substantial deceleration in cloud growth for the current quarter.
Still, it appears investors are now looking through this downturn and toward the attractive long-term positives for Microsoft and the tech industry at large. As a result, Microsoft rallied at the end of last week, ending the week 3.3% higher on the back of these three long-term positives.
Digital transformation to grow above GDP on a sustainable basis
While many market prognosticators have declared the tech trade "dead" and are espousing other sectors, Microsoft CEO Satya Nadella continues to be bullish on digital transformation. Cloud-delivered software and breakthroughs in super-computing have already led to a big shift in tech's importance to the overall market. Between 2010 and the end of 2021, technology increased as a percentage of the S&P 500 (^GSPC 1.20%), going from 23% to 42% of the index before last year's decline to a 37.5% weighting.
While some believe those outsized share gains might revert back to other sectors, Nadella maintained his conviction that "digital spend as a percentage of GDP is only going to increase... I fundamentally believe tech as a percentage of GDP is going to be much higher and on a secular basis."
For instance, despite the current slowdown in Microsoft's most important cloud segment, Nadella thinks cloud computing remains in its "early innings," noting customers are running twice the instances on Microsoft's cloud than they did pre-pandemic. Nadella also noted usage across a wide range of Microsoft applications remains up, despite new seat growth being more challenged as businesses pull back on hiring.
Yet cloud helps organizations do more with less, run more efficiently, and keep tech expenses variable, as opposed to having to build out and run one's own data centers. Nadella noted that customers are now optimizing workloads to run as efficiently as possible after the pandemic-induced acceleration. However, once that gets done, Nadella predicts customers will eventually begin to ramp up new workloads, perhaps within a year.
While Azure cloud growth will no doubt decelerate somewhat off of a bigger revenue base, it should maintain high growth rates relative to the rest of the economy over the longterm.
AI is not just a fad
This was Microsoft's first earnings call since the release of OpenAI's ChatGPT chatbot to the public on November 30. There is considerable debate these days as to whether this hypercapable AI tool is revolutionary or just a passing fad with limited capabilities.
If it's the former, then that could usher in a new growth era for AI-related companies as well as the semiconductor companies that fuel AI's massive computing needs.
On the conference call, Nadella noted that in just one week since making its OpenAI service available on Azure, over 200 Microsoft customers had already tried the service. Over one million people have used Github Copilot, an AI-enabled assistant that helps developers write code. And although much of the focus has been on how ChatGPT might improve Microsoft's distant second-place search service Bing, Nadella said that "fundamentally, it's going to be something that's going to drive, I think, innovation and competitive differentiation in every one of the Microsoft solutions by leading in AI."
There's a school of thought that AI may have crossed a threshold to becoming very effective for a wide range of use cases for the first time this year. If that's true, it would only elevate the importance of the tech sector beyond where it already is.
Image source: Getty Images.
PCs are in a historic slump but should bounce back
The biggest driver behind Microsoft's slowing growth is the hideous declines in its PC-related segments, including the Windows operating system and its in-house Surface hardware products. Last quarter, Microsoft's Windows and Devices segments each plummeted 39%. That should perhaps be no surprise, as research firm Gartner recently said worldwide PC shipments fell 28.5% in the fourth quarter of 2022, a historic year-over-year decline that was the largest since Gartner began tracking PC shipments in the mid-1990s.
And yet, there is still some evidence the work-from-home trend may have staying power. Nadella noted that while shipments are undergoing a violent correction, the installed base of Windows PCs remains at an all-time high, and usage per PC is 10% above pre-pandemic levels.
As many consumers and companies loaded up with a brand-new PC in mid-2020 and into 2021, it stands to reason that most are holding off new refreshes in 2022 and the early part of 2023, especially as everyone is looking to limit spending wherever they can.
However, if PC usage stays at these elevated post-pandemic levels, that higher installed base will eventually have to be refreshed. So while the 2020 and 2021 sales numbers may not return, PC sales should stabilize at 2019 levels at the very least and will likely settle into a higher level than 2019 going forward.
Higher for longer
Although the tech sector saw a violent correction in 2022, and 2023 revenue and earnings are likely to be lackluster across the sector, it appears technology usage and its value to businesses and consumers alike are still increasing. That means the tech sector should still be a sector to target for longer-term growth investors.
