Tech And Growth Stocks: Positioning Your Portfolios In Q2 2022

Investment Thesis

We are in Q2’2022! Just slightly more than a month ago, the unthinkable happened as Russia invaded Ukraine. Even though the signs were brewing, few would have thought Russia would launch a full-scale invasion.

For a while, it seemed like the potential bottom in the tech correction could potentially be thwarted. Moreover, the Invesco QQQ ETF (QQQ) then briefly dipped into a bear market, beating the SPDR S&P 500 ETF (SPY) to it.

However, we were not unduly concerned. We had been monitoring the market very closely. Furthermore, we informed members of our service that the bottom could be near, despite the extreme pessimism. If you saw the multitude of indicators that we were monitoring, you would have been stunned at the levels of pessimism.

Not surprisingly, the QQQ emerged from its brief bear market rapidly. Despite the expected retracement this week, it was a resounding recovery from the February/March bottom. So, as we move deeper into Q2, we thought it would be helpful if we shared some insights on how investors can position their growth and tech portfolios.

Semiconductors: Focus on Enterprise, Hyperscaler, Automotive

The Russia-Ukraine conflict has led to much anxiety over the state of the semiconductor supply chain. Russia and Ukraine supply between 25-50% of the world’s semiconductor-grade neon. Furthermore, Russia also supplies 40% of the palladium used in chip making. Therefore, investors were concerned that the chip supply chain could be stretched further, causing more mayhem.

However, supply chain checks showed that chip makers have a resilient buffer and are unlikely to be impacted in the near term. However, if the conflict gets drawn out over time, the impact could be keenly felt. Nonetheless, the Semiconductor Industry Association also highlighted (edited):

The bigger risk right now is probably the potential for neon pricing increases. However, it should be manageable as neon is a tiny fraction of the cost structure of the industry. – Barron’s

Hence, we think it’s critical for investors to invest in semi-players with a solid product roadmap catering to enterprise, data center, hyperscaler, automotive and industrial uses.

These are higher-margin segments that could help buffer the impact of the raw material costs increases. Furthermore, the reopening cadence has also spurred additional investments from these verticals as workers returned to the office.

Investors should also observe the gross margins to ensure that they don’t invest in companies with weak margins profiles. They should also be wary of investing in companies with sizeable exposure to lower-margin consumer products without enterprise/hyperscaler counterbalancing. For example, we have noticed a marked decline in Q1’s lower-end and mid-tier smartphones sales, especially on the Android OS. Therefore, it would be vital to focus on smartphone players with leadership in the higher-end segments.

Ad Tech: Focus on Identifier Changes to iOS and Android OS

Apple’s App Tracking Transparency (ATT) has caused more than a stir in the digital advertising industry. eMarketer reported recently that Meta (FB), Snap (SNAP), Twitter (TWTR), and YouTube (GOOGL) (GOOG) collectively lost an estimated $9.85B in H2’21 due to ATT. Furthermore, Meta also highlighted that it expects to take a $10B hit from Apple’s changes in its previous earnings call.

We discussed in a recent article that Meta CFO David Wehner telegraphed that it has been investing aggressively to rebuild its ad tech. It has also invested in AI/ML projects to reduce its dependency on data moving forward.

In addition, Google has also moved ahead with its privacy sandbox initiative on its Android AdID. The company has committed to a more collaborative approach than Apple. Nonetheless, we don’t expect significant changes in Q2. Notably, even its web-based cookies project has been deferred to 2023. Multiple web-based identifiers have been proposed to replace its cookies. But, it’s still early to determine which of these projects would be successful. As we move closer to 2023, ad tech investors should continue to pay attention to these developments.

However, Apple may not be done with its ATT framework yet. The Information reported recently that it could be introducing two new changes to “make it harder” for advertisers to work around ATT.

Notably, it’s to help ensure that these workarounds do not compromise the basic premise of ATT. You have to believe that Apple is doing it with the security of its users and ecosystem integrity in mind first. Even Berkshire CEO (BRK.A) (BRK.B) Warren Buffett emphasized (edited): “Tim Cook, Apple’s brilliant CEO, quite properly regards users of Apple products as his first love…”

Roblox (RBLX) also weighed in recently on Apple’s case with Epic Games. It emphasized (edited): “Apple’s process for review and approval of apps available on the App Store enhances safety and security, and provides those apps greater legitimacy in the eyes of users.”

Cybersecurity: Focus On Zero Trust Players and Cloud Security

The debate over Gartner’s definition of Security Service Edge (SSE) and Secure Access Service Edge (SASE) will rage on. Gartner introduced the SSE to differentiate cybersecurity players without the legacy SD-WAN capability in SASE. Legacy players have contended that SD-WAN is critical in the SASE framework. However, next-gen cybersecurity players who don’t utilize SD-WAN in their security architecture emphasized that it’s not necessary.

Cybersecurity companies have also seen a resurgence due to the Russia-Ukraine conflict. In addition, Okta’s (OKTA) hack by Lapsus$ has further intensified the focus on CISOs. We saw Google Cloud acquire Mandiant (MNDT) to enhance its MDR capability.

We expect more consolidation to continue in Q2’22 as companies tighten their screws on their security infrastructure. Notably, federal agencies should also be accelerating their momentum towards zero trust. Therefore, investors should continue looking out for companies with top-notch zero trust capabilities to invest in. Zero trust adoption is still in its infancy but is expected to accelerate rapidly moving forward.

Electric Vehicles

Tesla (TSLA) is expected to release its Q1’22 production and deliveries update on April 2. NIO (NIO), XPeng (XPEV), and Li Auto (LI) delivered a robust March report card. Therefore, it demonstrated that the EV adoption cadence continues to be strong in China, despite the scaling back in subsidies.

EV investors should continue to invest in leaders with a robust roadmap integrating hardware and software. In addition, investors should consider companies with proven manufacturing ramp rather than upstarts. In a tight supply chain environment, leaders with proven manufacturing ramp would be able to acquire needed supplies from their suppliers much more easily. While we don’t expect the raw materials disruption and price surges in critical materials like lithium and nickel to be prolonged, it could adversely impact production. Therefore, supply visibility is vital, and leaders with such visibility should continue to outperform in Q2.

Software

SaaS stocks had been marauded over the past four to five months, heading into Q2. King of SaaS, Microsoft (MSFT) trades at 10.7x NTM revenue. It was 12.3x at its November peak. However, the rest of its SaaS peers saw even more significant declines as investors bailed out of SaaS stocks. High-growth SaaS stocks saw their valuations fall from 23.9x NTM revenue in November to 13.1x currently. The bifurcation in the premium between Microsoft and these so-called high-growth SaaS has closed markedly.

Some of these companies were hit by the digestion of the remote working premium, which saw led to markedly weak guidance from their recent earnings card. Therefore, investors who invest in high multiple SaaS stocks need to be very cautious in justifying their premium. We suggest asking why their selections deserve to trade above MSFT’s multiple as a benchmark. That would help investors make sense of the competitive moat of these SaaS plays.

Nevertheless, the SaaS outlook in Q2 looks much more attractive than at the start of Q1 given the digestion of their premium.

Key Takeaways

We believe that tech and growth stocks are still alive and kicking. These are secular themes that would continue to play out over time. Therefore, the focus in Q2 would be to identify which of these players would be better positioned from a supply chain and high inflation perspective to perform better.

We hope that you have found our guide helpful.

Please comment and share which are your preferred growth and tech stocks to navigate the challenging environment in Q2!

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.