Technology Sector Navigates Tariff Complexities: Investment Strategy for 2025

OCBC Investment Research Private Limited
April 2025

Navigating the Tech Maze: OCBC’s Analysis of US Tech Stocks Amid Tariff & Policy Uncertainty

The US Technology sector has experienced significant volatility following President Trump’s “Liberation Day” speech on April 2, 2025. Investors are currently navigating a complex landscape marked by evolving tariff risks, policy uncertainties, and macroeconomic pressures expected to impact various subsectors unevenly.

Despite these challenges, the overall risk-reward profile for the Technology sector still appears favourable. However, the complexities necessitate a nuanced approach rather than a simple subsector ranking to achieve optimal investment outcomes.

Investment Landscape Overview

A detailed look across the technology subsectors reveals distinct challenges and opportunities:

• Internet: Valuations, especially for mega-caps, seem attractive. Preference is given to large digital advertising platforms strong in direct response advertising and AI monetization. Cloud spending is expected to remain robust, while ride-hailing/food delivery may show resilience. E-commerce winners will likely be market share gainers, but Online Travel faces significant headwinds due to its discretionary nature.
• Semiconductors & Hardware: The near-term outlook is murky pending announcements on sectoral tariffs and the AI diffusion rule. AI semiconductor players, particularly custom chip makers exposed to secular trends, are preferred. Caution is advised for consumer/analog semis and hardware names tied to PCs/smartphones due to potential negative earnings revisions. US semicap equipment players face market share risks from tariffs but could benefit from supply chain onshoring duplication.
• Software: Less likely to be directly hit by tariffs initially, but vulnerable to second-order effects like cautious IT spending. Preference leans towards companies focused on large enterprises, with minimal federal agency exposure, strong AI application/monetization potential, and offering mission-critical services (e.g., cybersecurity).

Internet Sector: Uneven Impacts Across Verticals

Digital Advertising

Corporates may reduce advertising budgets to manage margins amid potential end-demand pressures. In this scenario, advertisers are expected to favour large-scale platforms over experimental ones, focusing intensely on Return on Advertising Spend (ROAS). This shift should benefit direct response advertising over brand advertising. Furthermore, platforms demonstrably applying and monetizing AI are likely to gain investor favour. For example, Meta’s generative AI tools are seeing adoption, with over 4 million advertisers using them for campaigns, and its AI-powered ad ranking system is improving ad personalization and quality.

Preferred Pick: Alphabet [GOOG US/GOOGL US; BUY; FV: USD233] is favoured among large advertising platforms.

Cloud Computing

The outlook for cloud growth remains constructive due to its secular nature and low current penetration rates, suggesting continued workload migrations. However, policy uncertainty could cause some corporates to delay decisions, leading to marginal increases in workload optimizations.

Preferred Pick: Alphabet (Google Cloud) is preferred, partly due to Amazon’s (AWS) potentially higher exposure to government agencies.

E-commerce

This segment could face immediate impacts from macro headwinds due to its consumer focus. E-commerce players might need to increase promotions and incentives to drive conversions, potentially pressuring margins. In a slower growth environment, market share gainers are favoured.

Preferred Pick: Amazon [AMZN US; BUY; FV: USD274] is preferred due to its potential to gain retail market share, vast selection, competitive offerings, and strong balance sheet.

Online Travel

Caution is advised for the Online Travel segment due to the discretionary nature of travel spending. Recent data supports this view: the University of Michigan’s Index of Consumer Sentiment fell for the third consecutive month in March, hitting its lowest level since November 2022, driven by deteriorating expectations for personal finances, unemployment, and inflation.

Ridehailing & Food Delivery

These categories are viewed as relatively resilient entering a softer economic period. As a percentage of household expenses, spending in these areas has remained fairly stable historically, declining markedly only during severe economic dislocations like the 2008-09 Global Financial Crisis and the 2020 Covid-19 pandemic.

Semiconductors & Hardware: Awaiting Clarity Amid AI Focus

Sectoral Risks and Resilience

Semiconductors face risks from potential US tariffs, both directly and indirectly through end-demand destruction caused by economic slowdowns and higher product prices. While currently exempt from reciprocal tariffs, semis are expected to fall under forthcoming sectoral tariffs signaled by President Trump. The high margins typical of US semi players might offer some mitigation. Direct impact from potential Chinese tariffs is expected to be limited, as most US-designed chips are manufactured, assembled, packaged, or tested overseas before direct shipment to China.

AI Semiconductors Favoured

Preference is given to AI semiconductor names due to the enduring secular AI trend and relative resilience to economic slowdowns. Recent upbeat comments from Google and Amazon regarding hyperscale spending commitments, which drive AI semi demand, contrast with concerns raised by another large hyperscaler about slowing spending. Even if tariffs increase data center costs, significant capex cuts are not anticipated due to:

1. Very strong inference-related demand.
2. The ongoing strategic importance of achieving Large Language Model (LLM) leadership.

While both GPUs and custom Application Specific Integrated Circuit (ASIC) chips benefit from secular trends, custom ASICs are preferred currently. Merchant GPU players face greater near-term headwinds from the upcoming AI diffusion rule and recently announced export licensing requirements.

Hyperscale Spending Signals

Recent comments from tech giants remain largely positive despite tariff threats:

Source: CNBC, Reuters, Yahoo, Internal estimates (as cited in the original report)

Chip Design Software

This segment is viewed as relatively defensive due to its exposure to semiconductor firms’ R&D spending, which tends to be sticky even during downturns. Robust demand is expected to continue, driven by increasing chip complexity and design activity.

Consumer & Analog Semis Under Pressure

Consumer semiconductors, including commodity memory like NAND and DRAM (excluding HBM) used in price-elastic products (PCs, smartphones, consumer appliances), face higher risks of demand destruction and margin compression from potential tariffs compared to less price-sensitive markets like servers/AI. Weak US consumer confidence could further dampen sentiment. In the analog space, while the worst may be over, there are few signs of restocking, although some near-term pull-forward demand might occur as firms and consumers try to preempt potential tariffs.

Hardware: PCs, Smartphones, and Consumer Electronics

Although smartphones, computers, and other consumer electronics were announced as exempt from reciprocal tariffs on April 11, President Trump indicated they would still face upcoming sectoral tariffs. For goods like video game consoles, laptops, and smartphones, the US import mix remains heavily skewed towards China.

US Imports Mix from China (Selected Categories):

• Video Game Consoles: 87%
• Laptops/Tablets: 79%
• Smartphones: 78%
• Monitors: 67%
• Speakers + Headphones: 50%
• PC Accessories: 19%
• IoT: 15%
• Desktops: 2%

Note: Data sourcing described in original report involving US Census Bureau, CTA, WITS. Latest detailed data points vary by category, generally referencing 2021-2023.

While eventual tariffs on these categories might be lower than current China tariffs, the impact could still be significant for supply chain companies and consumers. Supply chains can shift (e.g., ODMs using locations like Vietnam for PCs), but large-scale transitions take time and are costly. Therefore, expect higher prices and lower sales for PCs during this transition, creating headwinds for PC players.

Semicap Equipment

US-based semiconductor capital equipment players could lose market share if tariffs allow non-US competitors to offer similar equipment more attractively. Additionally, reduced demand for tech gadgets could lessen the need for chips, thereby slowing chip manufacturing expansion and equipment orders. However, a potential positive offset comes from the duplication of equipment likely required due to the onshoring of supply chains, which could benefit semicap equipment companies overall.

Software Sector: Indirect Impacts and Strategic Preferences

Macro Uncertainties and Tariff Effects

The recent software selloff reflects macroeconomic uncertainties stemming from concerns over government spending cuts (related to DOGE), tariff headwinds, and a potential economic slowdown. Scrutiny over the federal IT budget creates demand uncertainty for software vendors with significant government agency exposure, potentially leading to delayed contract renewals, project cancellations, or reduced seat licenses due to layoffs.

While tariffs on goods don’t directly hit software (due to the difficulty of tariffing services), software firms face second-order effects. Enterprises might reduce IT spending in response to a deteriorating economy caused by tariff headwinds, leading to a slowdown in software demand.

Client Focus: Large Enterprises vs. SMBs

Preference is given to software companies serving larger enterprises (e.g., Fortune 500) over those exposed to small and medium-sized businesses (SMBs). SMBs could be more immediately impacted by macro uncertainties, potentially pausing spending initiatives. Since personnel costs are a large part of SMB expenses, significant workforce reductions under economic pressure could be a major headwind for vendors serving this segment.

Tariff Risk Profile

For investors seeking tech exposure, the tariff risk for software appears more indirect compared to hardware and semis. Enforcement is difficult as software is often delivered locally via cloud infrastructure within specific tax jurisdictions. No firm announcements on software tariffs have been made. However, a potential risk exists: countries might retaliate with tariffs on services (where the US is a net exporter) to gain leverage in negotiations, though this is not the base case scenario.

AI Resilience and Valuations

Software companies exposed to the structural AI trend are considered less likely to be disrupted. AI-related budgets are expected to remain resilient due to the potential for cost savings and efficiency gains – increasingly vital during economic slowdowns. AI also offers strategic differentiation in a competitive landscape.

The recent selloff might offer better entry points and more appealing valuations for software stocks. Valuations could also find support from ongoing M&A activity, such as Google’s acquisition of Wiz, which could benefit cloud security solution providers.

Investment Preference Summary for Software

Favoured software companies generally exhibit the following characteristics:

• Limited exposure to federal contracts.
• Greater exposure to Fortune 500/large enterprises compared to SMBs.
• Exposure to the structural AI trend with reasonable monetization potential.
• Primarily offer mission-critical services (e.g., cybersecurity solutions).