Software's New Economic Drivers
The maturation of the technology industry means software vendors can watch macro economic measures - as well as IT market developments - as indicators of future growth, valuation and stock performance. Here are the trends to watch.
By Rick Sherlund, Goldman Sachs
Sep. 30, 2005
The macroeconomic influence on tech is greater than ever as tech has grown to
become the single largest component of corporate capital spending - now almost
40% of the total.
IT spending was able to well outpace economic growth as it grew as a proportion of GDP from 1.5% in 1970 to almost 5% in 2000. Since settling in at less than 4% in recent years, tech is likely to resume growing as a percentage of the economy, but not nearly at the rate of decades past.
Not surprisingly then, the correlation of IT with the broader economy has jumped from less than 0.1 in the 1970s to over 0.9 in recent years as the industry has matured.
While tech continues to benefit from "mini-waves" of technology shifts (e.g.,
wireless), there are not the rapid, landscape-changing shifts that drove feverish growth in the 90s. In addition, many of today's technology trends actually serve to reduce aggregate IT spending.
Because it is a greater proportion of overall capital spending, IT spending is
typically better correlated with capital spending than with GDP. Capital spending growth tends to lag GDP by one or two quarters.
Semiconductor sales tend to lead IT spending by a quarter or two.
Both GDP and capital spending growth appear to have peaked in recent quarters,
which may mean decelerating IT spending growth ahead. In addition,
semiconductor sales growth has decelerated significantly in recent quarters. Such a move has historically preceded a slowdown in IT investment.
GS Wavefronts trading strategies indicate sector sensitivities to macro moves
The Goldman Sachs Equity Trading Strategies research team has developed
proprietary quantitative models- GS Wavefronts - to estimate sub-sector sensitivities to moves in an assortment of key macroeconomic indicators.
Sensitivities to each macro indicator below are based on estimated impact to the various components of the Dupont valuation model (i.e., the component parts of ROE such as net margin, asset turnover, and leverage) that ultimately affect stock prices.
The GS Wavefronts model indicates that semiconductors, semiconductor capital
equipment, and communications equipment have the highest sensitivities to
measures closely related to economic growth - GDP, consumer spending, capital spending, and foreign growth. Of these indicators, the model suggests that GDP growth has the highest impact on sector value, while the other three above-listed indicators have a moderate impact.
Additional macro indicators that tend to have an impact on the semiconductor,
semiconductor equipment, and communications equipment sectors disproportionately are short-term interest rates and oil prices. Of these two indicators, oil prices tend to have a high impact on value, while short-term rates have a low impact.
Two other macro variables - 10-year rates and the dollar - affect the hardware, services, and Internet sectors disproportionately rather than the semiconductor, semiconductor equipment, and communications equipment sectors.
None of the macro variables below have a significant impact on software sector
value, according to the Wavefronts model.
Based on swelling oil prices and potential near-term risk to consumer spending,
the GS Wavefronts model would suggest that the semiconductor, semiconductor
equipment, and communications equipment sectors are currently the most at risk
from macro factors, although the specific timing of any value impact on financial results and stock prices is uncertain.
become the single largest component of corporate capital spending - now almost
40% of the total.
IT spending was able to well outpace economic growth as it grew as a proportion of GDP from 1.5% in 1970 to almost 5% in 2000. Since settling in at less than 4% in recent years, tech is likely to resume growing as a percentage of the economy, but not nearly at the rate of decades past.
Not surprisingly then, the correlation of IT with the broader economy has jumped from less than 0.1 in the 1970s to over 0.9 in recent years as the industry has matured.
While tech continues to benefit from "mini-waves" of technology shifts (e.g.,
wireless), there are not the rapid, landscape-changing shifts that drove feverish growth in the 90s. In addition, many of today's technology trends actually serve to reduce aggregate IT spending.
Because it is a greater proportion of overall capital spending, IT spending is
typically better correlated with capital spending than with GDP. Capital spending growth tends to lag GDP by one or two quarters.
Semiconductor sales tend to lead IT spending by a quarter or two.
Both GDP and capital spending growth appear to have peaked in recent quarters,
which may mean decelerating IT spending growth ahead. In addition,
semiconductor sales growth has decelerated significantly in recent quarters. Such a move has historically preceded a slowdown in IT investment.
GS Wavefronts trading strategies indicate sector sensitivities to macro moves
The Goldman Sachs Equity Trading Strategies research team has developed
proprietary quantitative models- GS Wavefronts - to estimate sub-sector sensitivities to moves in an assortment of key macroeconomic indicators.
Sensitivities to each macro indicator below are based on estimated impact to the various components of the Dupont valuation model (i.e., the component parts of ROE such as net margin, asset turnover, and leverage) that ultimately affect stock prices.
The GS Wavefronts model indicates that semiconductors, semiconductor capital
equipment, and communications equipment have the highest sensitivities to
measures closely related to economic growth - GDP, consumer spending, capital spending, and foreign growth. Of these indicators, the model suggests that GDP growth has the highest impact on sector value, while the other three above-listed indicators have a moderate impact.
Additional macro indicators that tend to have an impact on the semiconductor,
semiconductor equipment, and communications equipment sectors disproportionately are short-term interest rates and oil prices. Of these two indicators, oil prices tend to have a high impact on value, while short-term rates have a low impact.
Two other macro variables - 10-year rates and the dollar - affect the hardware, services, and Internet sectors disproportionately rather than the semiconductor, semiconductor equipment, and communications equipment sectors.
None of the macro variables below have a significant impact on software sector
value, according to the Wavefronts model.
Based on swelling oil prices and potential near-term risk to consumer spending,
the GS Wavefronts model would suggest that the semiconductor, semiconductor
equipment, and communications equipment sectors are currently the most at risk
from macro factors, although the specific timing of any value impact on financial results and stock prices is uncertain.
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