Technology stocks probably wont lead the next bull market.  Not only is the great post-Internet digitization wave near complete, lots of so-called tech stocks arent really in the tech business. As a slowdown in 2023 takes form, a sorting out in the technology space that already began last year should gather pace.

The search for growth is (temporarily) over

If I told you a company was growing revenue by 30% a year and half of its incremental revenue falls to the bottom line because its business was scalable, wouldnt you be excited to invest? In the post-2008 world, many were. With markets haunted first by the specter of so-called secular stagnation and then upended by the pandemic, companies that sold  narratives like that were the leaders.


Thats no longer the world were in now, though. Not only is the market jittery about a potential recession, its also contending with periodic fears about the exact opposite  excess growth (if there is such a thing!).  And it looks like the later camp may be right. The chief concern today is not stagnation, its overheating and inflation. And that means the obsession with growth stocks  whose valuations are affected far more by high interest rates than old-line ones is on hold for the foreseeable future.

The upshot of this new investment climate is a re-think of exactly what the term technology company means. Retail, auto and media companies masquerading as tech companies (see below) will come under increasing scrutiny as their margins shrink and their inherent cyclicality becomes obvious.

This outlook creates a bifurcation in market performance within the world of companies now labelled technology. As a result, the future is likely to be  one where growth and tech are no longer synonymous. Outperformance will come from a select group of companies with high margins, low asset profiles, and network effects that act as moats around their core businesses. Yet I suspect that even those firms will have lower growth profiles because the digital revolution is reaching its end stages.

Netflix and Tesla arent tech companies

Two examples. Netflix isnt a technology company. Its a media company. Tesla isnt a technology company, either. Its a car company. That matters. It affects not only margins. It also reflects their ability to keep fend off competitors with network effects. The shakeout weve seen so far in technology is partially illustrative of this fact. The worst performers among the pandemics leading eight mega-cap tech stocks are ones with large non-tech businesses like Tesla, Amazon and Netflix or with non-software business models like Nvidia.

Meta stands out as the outlier of true tech companies. Its name tells you all you need to know about why it has underperformed since the metaverse is mostly a bust so far. The other software companies  Microsoft, Alphabet and Apple  have fared much better than the rest of big-cap tech. Its no coincidence that Apple and Alphabet both benefit from their mobile OS duopoly and Microsoft and Apple from their computer OS duopoly.  Here you have recession-resistant companies that are almost utilities, but with high margins, low variable costs and the sustainable competitive advantage of duopoly.

No brick and mortar company can replicate the big three of Apple, Alphabet and Microsoft. Amazon with its Amazon Web Services division is the closest as AWS is a basic backbone of the cloud-based computing world we live in. And even with that driver of growth and margins, Amazon has seen its market cap cut in half. After all, its core retail business, at root, is no different than Walmart.

Back to the technology company future

Now go back to the pre-Internet days and think about technology companies. I think its a pretty good reference point for whats to come. Back then, the company profile of excellent growth, high margins, low assets and sustainable competitive advantages wasnt a tech thing at all. In the 1990s, it was companies like Disney or its 1996 merger partner Capital Cities/ABC that better defined those characteristics. Tech, in the form of stalwarts like IBM and AT&T , was under assault. And outside of Intel in its duopoly with Microsoft, the hardware side of tech was cyclical and asset heavy, rarely demanding a higher price/earnings multiple than companies from other industries.

The Internet changed all that. Look at

how the Federal Reserve has described employment in the technology sector, for example:

The distribution of employment across tech-sector industries has been continuously shifting since 1990. Until 1996, the majority of tech employment was in manufacturing, accounting for approximately 60 percent of the high-tech workforce. However, service firms have come to dominate the tech economy. Today, nearly 80 percent of tech workers are in services, with the computer systems design industry accounting for the largest fraction of total tech jobs (41 percent).

Thats a massive change. And its made technology companies today more likely to have the enviable business characteristics that fuel high earnings growth, including network effects as a competitive advantage and high operating leverage in a world that was digitizing quickly.

So whats the quintessential tech company? Take the proto-Internet version of Microsoft. Heres a company that had a veritable monopoly on operating systems and  productivity software. It was operating in a world that was quickly digitizing, so top-line growth was high. And software is an asset-light business, meaning Microsofts expenses and assets didnt rise nearly as quickly as revenue. The result was a near 70-fold rise in the stock price in the pre-Internet bubble period from its 1986 IPO to the 1996 IPO of Yahoo in April 1996.

The Internet made software king

Once we got the Internet and connectivity exploded, software became king in the tech world. The only limitation to any software-based business model was bandwidth and user adoption. That made tech synonymous not only with growth but scalable growth  when a companys earnings grow much more quickly than revenue.

I think that era is over now. Bandwidth is high enough in advanced economies for the digitization of almost everything. And connectivity is ubiquitous for both fixed line and mobile access. That makes digital-only businesses less unique in terms of growth prospects. You only need to look at the streaming wars that caused Netflix shares to tumble, for example, to see that shift play out. Moreover, with recession looming and investors shunning pie in the sky business-model claims, the utility-like performance of the recession-resistant big three  Alphabet, Apple and Microsoft is enviable. It makes them less growth and more value companies these days  so much so that even Warren Buffet is investing.

By the numbers

  • Nearly $5 trillion -Loss in market capitalization in 2022 of Apple, Amazon, Alphabet, Meta, Microsoft, Netflix, Nvidia, and Tesla

What happens next is bad for growth tech

As in 2022, I think the biggest driver in 2023 will be monetary policy. Central banks see an un-anchoring of inflation expectations as the biggest tail risk. The result is

an asymmetry, where they are aggressive in 

tamping down on perceived inflationary impulses but not easing as

inflation recedes. Recent statements from Fed officials and the release of the last FOMC minutes suggest enough of a restrictive policy to kill growth and the appeal of so-called growth companies with it. How long this mood lasts is anyones guess. But in combination with the inherent slowing of tech growth due to a lack of new digitization options, its poison for the more speculative tech companies. Its not that the technologies and companies that will lose are bad one. Its just that their technology wont scale enough before the funding tide goes out.

For example, when I moved to New York in 1999, I glommed onto a service called Richochet that made high-bandwidth wireless routers that massively increased Internet speeds. Then its provider, Metricom, ran out of money when the Internet bubble popped. They went bankrupt and shut Richochets service down because the mere 51,000 subscribers simply werent enough to cover costs. So when the funding bubble stopped, so too did Richochet. Thats whats about to happen here now.

The growth companies that survive will be the ones that can turn off the capital investment spigot and fund expenses out of cash flow. That means lower growth and lower stock prices for some and bankruptcy and zero stock prices for others.

Vulnerable large cap tech stocks

In the large cap tech world, I flagged two companies

last April.

The next two most vulnerable stocks are Nvidia and Tesla. As Nvidia is already down some 40%, Tesla is the one to watch, having fallen by about 20% from its early November 2021 peak.

Nvidia is just a cyclical hardware company. Theres nothing remarkable about its decline. Its still lost a quarter in value since then. But Tesla has lost 64%. More importantly is that the bloodletting is not over for Tesla for exactly the reasons I described in April:

Yes, they still have an enviable position in EVs. But they are also vulnerable to the same kind of market entry Netflix has seen in streaming. And the EV market is at risk in a general economic downturn. 

In the context of todays post, the Netflix comparison matters because both Tesla and Netflix arent really technology companies. They are more vulnerable to competition as a result. And neither sells a must-have utility-like product. In a recession, that means growth comes to a screeching halt and operating leverage has a decidedly negative impact on earnings.

Crypto is a loser too

Ill end this with a note on crypto because I think of crypto as technology, too. Ive been a blockchain advocate for nearly a decade, largely because I see it as a potential winner in the last phase of digitization, the digitization of value.

Back in April 2021, I wrote

an opus to the concept that the last barrier to full-scale digitization was trust, with crypto as the potential solution. But what weve seen since then suggests

crypto simply wont be the solution. The situation around FTX and Sam Bankman-Fried tells you that. Value digitization will have to take a different path.


bad for crypto. Its not catastrophically bad in a Bitcoin-goes-to-zero kind of way. But it does mean that crypto wont have mainstream appeal for a long time  if ever. Expect prices to feel pressure as this outlook sinks in.

As we re-enter this brave old world be very suspicious of anyone hawking Artificial Intelligence as the next growth engine for tech to sustain its market glory. The days of blue sky thinking leading the market are over.

Quote of the Week

For growth stocks to work, you want to see improving fundamentals and estimates, and were not seeing that right now, which makes it hard to argue for multiple expansion.

Things on my radar

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