A Generational Shift in Technology Expands Products to a Wider Customer Base
- China’s leading Internet companies are enabling the country to leapfrog many economic paradigms that advanced countries traversed over recent decades.
- Investors are recognizing that semiconductors appear well positioned to capitalize on the rollout of the Internet of Things.
- There are risks which should be monitored including regulatory encroachment.
We see the technology sector’s recent solid performance as an indication that investors are beginning to recognize the magnitude of the generational shifts occurring within technology. This encapsulates not only innovative new products and services, but perhaps more importantly, the breadth of end markets in which they can be applied.
For example, in the third quarter, Internet stocks were among technology’s strongest performers. But rather than being driven by U.S.-domiciled giants, it was China’s dominant players that delivered some of the strongest returns. We expect that the rapid adoption of web-based services in China should allow the country to leapfrog the legacy economic paradigms that presently weigh down many advanced economies. Investors have also begun to coalesce around the view that semiconductors are well positioned to capitalize on the rollout of the Internet of Things (IoT).
Recent corporate results provide evidence that the transition to the cloud and the deployment of IoT are accelerating. We expect that the refinement and adoption of artificial intelligence (AI) will further entrench these themes as key shapers of the technology sector in the years to come. Both the cloud and IoT are now gaining traction in Europe and Asia. We believe the opportunity knows no geographical boundaries nor is it limited to any industrial sector. Instead, the shift to subscription-based cloud services will be horizontal, attracting a wider customer base than technology companies have historically relied upon.
Investors should keep a constant eye toward what risks may adversely affect the sector. At present, a major consideration is the possibility of regulatory encroachment. Indeed, we have recently witnessed a wave of events that have the potential to snowball into a movement calling for greater privacy protection for customers. Of note were the data breach at a credit reporting company impacting more than 100 million Americans as well as Russia’s use of social media advertising during the U.S. election season. So far, governments have largely shown a light hand toward Internet regulation. A possible shift may come from Europe where authorities are considering placing regulations on the use of data.
Some in the investment community lump current valuations into the bucket of potential risks. While we recognize that valuations across the sector have risen, we believe that additional price appreciation is possible without the support of multiple expansion. Instead, we believe the market is still likely underappreciating the sector’s earnings growth given the aforementioned generational shifts.
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Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.
Technology industries can be significantly affected by obsolescence of existing technology, short product cycles, falling prices and profits, competition from new market entrants, and general economic conditions. A concentrated investment in a single industry could be more volatile than the performance of less concentrated investments and the market as a whole.