While the world digests the fact that FTX could be heading to zero, Elon Musk continues to make headlines with changes to Twitter policy — at times seemingly on the fly — and results from the U.S. midterm elections still trickling in, there could be some fair winds blowing for tech companies.
This morning, the United States released new inflation numbers, with CNBC reporting that the consumer price index, or CPI, was up 0.4% in October and up 7.7% from the same month one year ago. Given expectations of 0.6% and 7.9% expansion, respectively, the report counted as an unexpected bit of positive news.
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Why? Because if inflation is cooling, then the pace at which the U.S. Federal Reserve will raise interest rates may slow. Slower rate increases would shift the calculus for investors, making assets like stocks — and tech stocks in particular — more attractive, and more conservative investments less so on a relative basis.
Based on our understanding of current market dynamics, a light inflation report should rally stocks. That is precisely what we saw this morning, meaning that tech companies are making up the ground that they lost yesterday, when stocks sold off once again.
It’s too early to be confident in calling a bottom to the valuations massacre that we’ve seen in tech over the last year, but as we approach the date in 2021 when we asked if the era of super-rich tech valuations was behind us, it may the correct time to wonder if we’re bouncing around the nadir of the tech valuations valley.
There are a few good reasons to think that we may be. In no particular order:
- Tech valuations have compressed past pre-2020 norms: Why should tech companies be worth less per dollar of revenue today than they were in 2020? Or 2019? The fact that tech companies benefited from the 2020 COVID recession remains true; the general move toward the cloud from legacy solutions persists; and tech shops still generate among the highest-margin, stickiest revenue in the world. No matter all that, the charts are clear: Tech shares have not been cheaper in years and years.
- The Fed can’t hike faster and may now raise rates more slowly: The recent pace of 75 basis-point (0.75%) hikes to the Fed’s key rate caused concern and consternation among investors. Now there’s talk that the next bump will be 50 basis points, or one-third less than some had expected. That’s good news for tech stocks, as we saw in this morning’s trading.
- Excess has been ripped from the market, leading to more sober tech companies that are perhaps more investable: Fat has been trimmed, staff cut, hiring freezes enacted and tech companies are generally doing more with less. Given that growth rates at many software concerns are holding up pretty well, we’re looking at reasonably quickly growing high-margin companies, now with lower operating costs. That smells like greater future cash flows, right?
- Weaknesses in the market have been exposed, implying that the bad news rush could be slowing: Sure, FTX imploding is not going to cause much positive energy in the crypto sector, but tech has already eaten a lot of crow this year. The ad market that helped power Big Tech’s epic last few years? Its slowdown has been digested. A new valuations climate? Consumed. Tighter corporate budgets? Now baked into growth projections. Given how many lumps tech companies have been forced to consume this year, it’s reasonable to wonder how many more could be on the menu.
The recent rediscovery that profitability is ~ cool ~ means that our objections about certain tech valuation principles retain weight. It is still likely that in a more conservative market, profitability multiples should be applied more broadly, and that revenue multiples less so. But that’s nuance. Even measured in revenue terms, there’s a new taste to the wind today.
If inflation continues to moderate in the final months of 2022, perhaps 2023 won’t be a repeat of what has been a forgettable four quarters for many startup founders, their backers and investors more generally.
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