We don’t know if the United States is in for a garden-variety recession, or, as Treasury Secretary Steven Mnuchin allegedly has warned U.S. senators behind closed doors, something far worse, with perhaps 20% unemployment.
What seems obvious is that there will be economic fall-out from the shutdown of businesses across the land, and that it might be milder if containment efforts stem Covid-19 in coming weeks, but it could also be much worse if quarantine efforts drag on for months or, a distinct possibility, infection rates surge again after initial abatement.
Against that backdrop, the way to think about recession is in two modes, which would occur roughly one after the other. First, a return to “core” tech purchasing, meaning some things get priority, such as restocking computers, while other types of spending take a back seat; and, secondly, the broad ramp-down of a lot of global economic activity, which would include semiconductor products and related technologies.
In the first case, core technology refers to the most essential tools for businesses to maintain a virtual workforce while they look to operate business within a lockdown of whatever duration. That’s good for computer makers such as Apple (AAPL) - Get Report and HP Inc. (HPQ) - Get Report, and it’s also good for cloud computing services operators such as Amazon’s (AMZN) - Get Report AWS service.
That return to core tech means less enthusiasm, however, for newer businesses that haven't proven their staying power, such as Uber (UBER) - Get Report and Lyft (LYFT) - Get Report and the sharing economy. As Global Equities Research analyst Trip Chowdhry quipped in a report on Wednesday, “C-19 has given another blow to the whole concept of ‘shared economy,’ basically, ‘Share and Get Infected.’” In other words, people will stay away from rides with strangers to minimize exposure.
Both stocks, though down 50% and 63%, respectively, this year, could fall further before their businesses stabilize. Uber has its “Uber Eats” business for serving take-out needs, which can do well in a newly take-out world, but that’s a mild offset to its main business of rides with strangers. A note from New Street Research analyst Pierre Ferragu on Wednesday opined that a decline in Uber’s dollar volume of rides, or “bookings,” of 30%, over the course of two quarters, is a realistic estimate for a worst-case scenario. Losing a third of your business is a big deal.
Another immediate victim will be Old Tech names that are more levered to large-scale capital investment by businesses. That could mean companies such as Oracle (ORCL) - Get Report, which sells database tools; Hewlett Packard Enterprise (HPE) - Get Report, which sells servers and networking; and networking giant Cisco Systems (CSCO) - Get Report. Although companies need databases to keep running, as well as servers and networking, they may not need to take out new subscriptions or licenses, and they may not need to spend as much on hardware if they are expecting to remain in some kind of holding pattern for their volume of business.
Now, Oracle, HPE, and Cisco shares are already down, respectively, 11%, 46%, and 23% this year, and Wednesday, their shares closed up amidst another market rout. But they can go much lower as bad news comes out about estimates for their business.
A number of smaller software makers face an interesting double-edged situation. Companies such as Slack Technologies (WORK) - Get Report, which makes the group productivity application, and Okta (OKTA) - Get Report, which secures corporate assets including for remote workers, may both see great upside for their software sales as businesses need what they offer more than ever to support an increasingly virtual workforce.
The only negative is that their shares are still historically expensive, with Okta fetching almost 17 times the $759 million in revenue projected for this calendar year, and Slack trading for 9.5 times the $966 million it’s projected to make. Both of them might hold up in terms of sales, but both stocks might be revalued downward in a recession simply because risk appetite is diminished in broad terms.
The second main phenomenon in a recession is the ramp-down of global economic activity, which would probably hit the semiconductor group the hardest at first. Certainly, chip production wouldn’t stop, but orders could very well be cut as economic growth slows dramatically.
Probably the most vulnerable are the highly diversified semiconductor makers that are often the “canary in the coal mine” for economic activity. These include companies such as ON Semiconductor (ON) - Get Report, Maxim Integrated Products (MXIM) - Get Report, Texas Instruments (TXN) - Get Report, NXP Semiconductors (NXPI) - Get Report, and Analog Devices (ADI) - Get Report. Their vast catalogs of parts show up in so many pieces of industrial and consumer equipment that they can be hit with declining orders on many fronts, from automobiles now sitting on the dealer lot as people quarantine, to gas and electric control systems for offices now less likely to be built or expanded.
The important factor to keep in mind with any assessment of losers is that every stock will be an alternative among many for investors. That means that business doesn’t have to get really bad for investors to rotate out of a stock in favor of putting money into something less-bad.
It’s possible that Arista Networks (ANET) - Get Report, for example, which supplies cloud computing networks, could be a less-bad alternative to a broad-based networking equipment company such as Cisco. A chip vendor such as Intel (INTC) - Get Report, which derives a large portion of its sales from server computers that make up cloud computing, may be more desirable to investors than a diversified chip maker such as Maxim that’s vulnerable to broad economic swings.
In other words, it’s not just the absolute impact on any company’s business one has to consider when investing, it’s the relative desirability of that company’s stock amidst a sea of alternatives.
In sum, stick with the core tech plays, things such as computing devices -- PCs and smartphones and cloud services -- and stay away from corporate infrastructure such as large, expensive software licenses. And watch out for the general landscape of diversified semiconductors.