How Regulation Could Impact Technology Stocks

How Regulation Could Impact the Technology Sector They were once the darlings of the growing US economy and bull market, but now technology companies are coming under intense fire from users and governments around the world. The online applications, platforms, and services once hailed as world-changing and revolutionary are now being viewed as deceptive and invasive. The threat of regulation not only looms but feels imminent. Taking a step back, we think it’s a good opportunity for investors to examine how new regulations could affect some of the biggest technology companies in the world, as well as the sector at-large. Build Your Investment Thesis Not by What Congress Says, But by What They Sign For all the hubbub we’re seeing today in the United States on the issue, few people realize that Europe is arguably well ahead of the curve in terms of regulatory action*. The framework in Europe is known as the General Data Protection Regulation, or GDPR. The GDPR will cover everything from giving users much more control over their personal data, to setting standards for how corporations can collect and use user data. The rules go into effect in May, and companies like Facebook, Google, and Apple could face billion-dollar fines if they fail to comply. Tech companies are not likely to take the regulations lightly either, as Google and Apple have already faced substantial fines for other breaches in the European Union. The question ultimately becomes, will US lawmakers follow the lead of Europe, write new rules of our own, or simply do nothing? In our view, we think any outcome will not result in the type of heavy-handed regulation that can fundamentally derail the tech sector’s ability to grow earnings. Our thinking is shaped on three factors. First is that the previous attempts of Congress to take action on this issue have failed. While Congress has shown some interest in data security legislation, particularly after big data breaches or scandals, it has never been able to get a bill across the finish line. Second is that for all the harsh rhetoric aimed at technology companies (particularly tweets aimed at Amazon), the president and the executive branch have very little power to intervene directly on any one company. The Justice Department could feasibly intervene with an anti-trust lawsuit, but that could drag-on for years and is not even in the rumor mill at this stage. Many readers might recall that the Justice Department tried a similar action on Microsoft two decades ago, but it ultimately went nowhere. The final point is that even if Congress manages to pass bipartisan legislation aimed at data protection and privacy rules, it seems unlikely that these rules would broadly hinder the business models for many companies in the technology sector. In theory, the rules would barely touch the large swath of companies selling software, hardware or cloud-related services – which actually represent a majority of companies operating in the technology sector today. Bottom Line for Investors In our view, new regulations on the biggest players in technology matter only to the extent they adversely affect digital advertising businesses and revenues, and as it stands today, it is very unclear what those regulations will even look like – if they happen at all. As mentioned before, Congress has to date failed to pass any comprehensive privacy law for the digital age, stumbling in oftentimes because of partisan mudslinging or outsized lobbying efforts from Silicon Valley. It’s difficult to fathom in the current climate how this go-round would be much different. As lawmakers likely string out this issue over months or even years, we think investors should continue to follow the money. The Information Technology sector is expected to report the third highest (year-over-year) earnings growth in Q1 of all eleven sectors, with a growth rate of +22.0%. At the industry level, all seven of the industries in this sector are predicted to report earnings growth, with five of them in double-digit territory: Semiconductor & Semiconductor Equipment (31%), Technology Hardware, Storage, & Peripherals (24%), Internet Software & Services (23%), Software (21%), and IT Services (18%).** Based on these numbers, a constructive view on the Tech sector seems fitting in the medium term. 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