Market conditions facing investors today are as complex and uncertain as many investors can remember.
After a tough year for most equity sectors in 2022, investors are wondering where to find returns in 2023. One area which investors might re-assess is technology. After a turbulent year, are we in the early stages of a tech recovery?
In the last decade, global tech has been the primary driver of equity market returns worldwide. Companies like Apple, Google and Amazon.com revolutionised our everyday lives and are well known for their relentless drive to innovate.
These companies, heavily represented in the NASDAQ-100 index in the United States have delivered high returns over a long period for those lucky early holders.
Source: Bloomberg. Performance to 15/03/23 and is shown in USD. Both indices normalised to 100 at 30/03/1990. Performance shown is that of an index and so does not take into account ETF fees and costs. You cannot invest directly in an index. Past performance in not indicative of future performance.
But the global tech sector sold off heavily in 2022, as rising interest rates discounted the future earnings that dominated the index’s valuation.
The tech sector (as measured by the NASDAQ-100 Index) fell from an average Price Earnings (P/E) multiple of 29.8 times in November 2021 to 19.1 times in June 2022. That compares to its 10-year average of 20.9 times.
A lower aggregate valuation and the anticipation of peak interest rates have led some investors to question whether global tech might soon come back into vogue.
The recent weakness in the US banking sector is a cause for concern, but the larger companies in the tech sector appear unlikely to fall victim to the contagion, in BetaShares’ opinion.
Larger tech companies typically have high cash balances and low leverage, which could potentially make them more resilient to any coming financial downturn.
In fact, if financial instability forces the US Federal Reserve to cut interest rates earlier than expected, the tech sector may even end up benefiting, in BetaShares’ opinion.
While many investors already have exposure to the US tech giants of the NASDAQ-100, the Australian technology sector offers unique characteristics that could potentially benefit investors.
The first thing that stands out when looking at Aussie tech - compared to the large global technology sectors in the US and China - is the prevalence of business-to-business (B2B) revenue models.
Of the top 10 holdings in the S&P/ASX All Technology Index, which tracks a basket of Australia’s largest listed tech stocks, half are B2B software companies, comprising 37% of the index capitalisation.
Source: Betashares, Bloomberg. Data as at 28/02/23
The revenue streams of these businesses tend to be stickier than those of consumer discretionary-focused firms, such as some US tech giants. Their long-term contracts and the difficulty of businesses switching essential software could provide support in the event of an economic downturn.
Moreover, the firms in the S&P/ASX All Technology Index derive a relatively high proportion (>50%) of their revenues overseas. Revenue priced in foreign currencies such as the US dollar means that exchange rate fluctuations may have a significant impact on their Australian-dollar revenues.
In economic downturns, history suggests investors typically sell off Aussie dollars in favour of traditional safe haven currencies such as US dollar.
As a result, the services that Aussie tech firms provide become more attractive to foreign customers in terms of their own currencies – or sales denominated in foreign currencies become worth more in Australian-dollar terms.
Despite these characteristics, Aussie tech still suffered badly during last year’s bear market. The S&P/ASX All Technology Index fell almost 45% between November 2021 and June 2022 - more than either the S&P/ASX 200 or the NASDAQ-100.
Increasing interest rates caused the Australian tech sector, which was trading at a P/E of 87 time at its peak, to fall sharply. The P/E fell to 37.5x in June 2022, lower than its 3-year average of 56.1 but still high compared to the NASDAQ-100.
However, the appeal of Aussie tech remains largely the same as it was at the launch of the S&P/ASX All Technology Index in 2020, and it maintains characteristics that differentiate it from both the NASDAQ-100 and the S&P/ASX200.
Information Technology makes up only a small fraction of the S&P/ASX200, and the sector is less mature than the US tech industry.
Yet, with our well-educated population and increasing government support, Australia’s nascent tech industry has the ingredients to become a powerful force in the economy.
The macro environment largely drove markets for the past year, and will continue to play an important role. As we near the predicted interest rate peak, investors are yet to reach a conclusion on what the next 12 months hold.
The biggest question is the same one that dominated last year – will central banks be able to tame inflation before high interest rates tip our economies into recession?
Australian investors may wonder: how will Australia fare compared to the rest of the world, particularly the US?
And for those looking to reallocate to technology, how will our respective industries fare in the various scenarios we might face?
The US and Australian tech industries display unique characteristics that make them attractive in various market conditions, in BetaShares’ opinion.
If the US enters an earnings recession while Australia manages to avoid one, Aussie tech could potentially outperform the NASDAQ-100 in BetaShares’ view, while allowing Aussie investors to maintain their tech exposure.
If the US recession is caused by troubles in the banking sector, however, the tech giants’ strong balance sheets may shield them compared to the broader US market.
In the event of a recession, Aussie tech’s B2B tilt and exposure to Australian dollar exchange rates are other important considerations.
If an economic downturn in either market is accompanied by a drop in inflation, a decrease in interest rates might deliver boost to that country’s tech sector.
The Betashares S&P/ASX Australian Technology ETF (ASX: ATEC) aims to track the S&P/ASX All Technology Index.
For those looking for a US exposure, Betashares offers the Betashares NASDAQ-100 ETF (ASX: NDQ), which aims to track the NASDAQ-100 Index, and the NASDAQ 100 ETF - Currency Hedged (ASX: HNDQ), a currency hedged version of NDQ.
 Bloomberg Terminal (PORT function) . BEst P/E Ratio Fwd 12M calculated by taking the weighted average of the current fiscal year and the next fiscal year estimated in proportion to the amount of time between now and the end of the current fiscal year.
 Betashares, Bloomberg Terminal (PORT function).
 Morningstar, as of 28/2/23. Data used is ‘Revenue Exposure by Region: Fund-level’.
There are risks associated with an investment in each of ATEC, NDQ and HNDQ, including market risk, sector risk and concentration risk. Investment value can go up and down. An investment in any of the funds should only be considered as a part of a broader portfolio, taking into account your particular circumstances, including your tolerance for risk. For more information on risks and other features of each fund, please see the relevant Product Disclosure Statement and Target Market Determination available at www.betashares.com.au.