Tech stocks: recession will divide sector and giants will win 

Recent first-quarter earnings from US tech stocks can be summed up as a relief.

In a sector known for growth and new ideas, revenue expansion rates of 3 per cent at both Meta and Alphabet hardly sound impressive. But at least this reverses the decline Meta reported last year. It also shows that global digital advertising spend is holding up. Corporate budgets are not quite as constrained as feared.

Add heavy cost-cutting via lay-offs, and the tantalising prospects from artificial intelligence, and the sector has managed a tricky task. It has explained why operating margins will be lower short term but may explode in a few years. Tech investment analysts at Wedbush predict that AI spend will hit $800bn over the next decade. McKinsey suggests AI could add about $6tn in value.

But the cost of AI, and concerns about potential recession effects, have opened a crack between the Big Tech stocks that can afford to invest and smaller companies struggling to turn a profit and unable to pour money into research and development.

US economic growth slowed to 1.1 per cent in the first three months of the year. Cautious corporate and consumer spending compares unfavourably with the height of the pandemic, when demand for tech products and services jumped. PC sales, for example, fell by a third in the first quarter, according to Canalys data. Cloud computing clients have scaled back demand. Amazon and Microsoft refer to this trend as customer spend “optimisation”.

Tech stocks have staged a recovery this year, but some of the largest companies are still trading about 30 to 40 per cent below their 2021 highs. The Nasdaq is up 6 per cent over the past year, compared with a 1 per cent gain for the S&P 500.

But software-as-a-service companies such as Zoom and DocuSign remain in the doldrums. This faultline will expand. Rising interest rates have raised the cost of capital. Companies able to use funds from profitable lines of business are much better placed than those still valued on growth.