Stocks were broadly higher on Monday following a punishing week of selling, as investors looked forward to the prospect that central banks around the world are going to cut rates to mitigate the economic impact of the coronavirus outbreak.
The Standard & Poor’s 500 index and the tech-heavy Nasdaq Composite both traded up more than 2%. This rejoicing may be short-lived, however, for tech has not yet begun to feel the true force of the current coronavirus epidemic.
Tech companies have seen little impact to their business thus far, but the still unfolding coronavirus pandemic could go in all kinds of directions from here, many of them bad, and that could hit tech sales in a big way.
With the exception of companies that are masquerading as tech firms, such as Netflix (NFLX) - Get Report, which is really more of a media company, and companies such as Apple (AAPL) - Get Report that sell gadgets to consumers, the majority of tech companies sell tools to businesses to manage their operations. Fully one third of technology sales are to corporations, not individuals.
And as business slows around the world in coming months, there could well be deep cuts in outlooks by tech firms that right now are relatively sanguine.
The virus is only starting to arrive in leading economies such as the U.S., but the expectation is for a fairly large global economic impact. The total number of confirmed cases as of Sunday in the U.S. was 62, and there was one death here, according to the World Health Organization. That’s almost double the week-earlier total of 35 cases, even as states such as Rhode Island are announcing their first diagnosed cases.
A preliminary assessment of the potential impact was provided in a note on Friday from Goldman Sachs portfolio strategist David Kostin and team. They have cut their view for S&P 500 earnings this year to zero growth over 2019, a situation they call “bleak.” That’s assuming the coronavirus turns out to be “widespread but short-lived”; a worse scenario is for the outbreak to cause a global recession, something they’re not ruling out.
From Microsoft (MSFT) - Get Report to Amazon (AMZN) - Get Report to Oracle (ORCL) - Get Report to Arista Networks (ANET) - Get Report, tech companies large and small, old and new, have to be affected if global business slows, as it is likely to. So far, there’s little of that in the numbers companies are forecasting, but the numbers don’t reflect much of what is to come since the firms don't really know any better than their customers what will happen.
Microsoft last week said it won’t make its previously-issued guidance for the May quarter because of “uncertainty” about the public health situation. But as TheStreet’s Eric Jhonsa related, several companies are seeing no impact at all, including Salesforce (CRM) - Get Report, which offered an upbeat quarterly outlook, and Box (BOX) - Get Report, which said it had yet to see an impact.
“Yet” is the key word here, however. The sales teams at tech companies have amazing forecasting abilities, but what they know for certain is only up to date through last week. And what they can predict about the future is probably of little worth in the midst of an outbreak that is evolving quickly around the world.
As New Street Research tech analyst Pierre Ferragu wrote in a note Monday morning, “the situation has deteriorated very significantly,” regarding coronavirus, “and early comments were only referring to the impact of days of production lost in China and China demand.”
“The problem is now shifting to global demand and a much longer and uncertain time frame," Ferragu noted.
As companies of all sorts take a pause in many functions globally, in order to be safe instead of sorry, that has to have an impact on their business activity, and, in turn, their spending on infrastructure, including software and services sold by tech firms.
To be sure, some portion of investment is going to continue. One area that could be relatively robust is cloud computing services such as Amazon’s AWS and Microsoft’s Azure. Cloud allows companies to buy computing power in an incremental fashion, without large sunk investments. It’s possible that in a crisis like the present one, companies may look to the cloud to make a permanent reduction in capital outlays in favor of just renting compute as needed.
That’s a nice silver lining, but investors should bear in mind that tech valuations, even after the sharp declines of the past week, are not cheap. Most tech stars such as Amazon, Salesforce and Microsoft trade well above the average of the S&P 500’s 18.25 times forward earnings, based on that Goldman Sachs outlook.
That's not to say that tech is “priced for perfection,” but it has been riding high for so long, most stocks have a long way to fall if the impact of the coronavirus turns out to be much worse than it now appears. That's something to keep in mind while dreaming of rosy central bank scenarios.