What happened
Shares of cloud software companies, including Appian (APPN -6.28%), Snowflake (SNOW -5.76%), and Shopify (SHOP -5.04%), were all moving lower today as downbeat economic data raised fears of a recession and sparked a sell-off in high-growth, tech stocks like these three.
Among the reports released was the ADP monthly payrolls, which showed that just 145,000 private-sector jobs were added in March, lower than estimates of 210,000 and down from 261,000 in February. In particular, the financial sector and professional- and business-services sectors were weak, losing 51,000 and 46,000 jobs, respectively. This seems to reflect the banking crisis, planned layoffs, and a decline in business activity that’s consistent with the arrival of a recession.
Growth in annual pay also slowed from 7.2% to 6.9%, which could help put the brakes on inflation. Investors will get the official jobs report on Friday, April 7, though the stock market will be closed that day for Good Friday.
Additionally, the ISM Services report also showed decelerating business activity, as the index declined from 55.1 in February to 51.2 in March, showing modest expansion in activity. The Federal Reserve has been particularly concerned about inflation in the services sector, so the report could help persuade the central bank to stop raising rates, especially if other data points confirm the slowdown in services. One metric showing prices that services businesses paid also fell to its lowest level in almost three years.
Both news items follow a downbeat report on job openings yesterday, painting a picture that the labor market is finally cracking after a year of aggressive interest-rate hikes by the Fed.
The increased concerns about a recession hit the tech sector particularly hard, as much of the sector has already seen slowing growth amid other headwinds. At the end of today’s session, Appian stock was down 6.3%, Snowflake had lost 5.8%, and Shopify finished the session down 5%.
So what
All three of these software stocks either trade at high valuations, are unprofitable, or are barely profitable, making them particularly vulnerable to a recession. Appian, which provides a low-code software platform to enterprise-level customers, said it expected growth to slow this year, due to demand headwinds.
After growing cloud subscription revenue by 32% in 2022, the company said growth in that category would slow to 24%-25% in 2023. It sees full-year revenue growth of just 13%-14%, compared to 27% growth in 2022.
Appian is focused on narrowing its losses, and CEO Matt Calkins has said the company is prepared for a recession. But the stock is still vulnerable to a downturn.
Snowflake, which is known as a cloud infrastructure company that provides data warehousing services, is one of the fastest-growing and highest-valued stocks in the software sector. Product revenue jumped 54% in its fourth quarter, and the company expects it to slow to 40% in 2023.
While that’s still a strong growth rate and Snowflake stock has fallen considerably from its peak, it still trades at a lofty price-to-sales ratio of 33. Since its business is consumption-based, it’s likely to feel a direct impact from a slowdown in the economy.
Finally, Shopify is the leader in e-commerce software, and e-commerce is largely based on discretionary retail spending, which also makes it sensitive to a recession. While it’s possible that a recession could encourage more entrepreneurs to start online retail businesses, it’s likely to dampen spending on the platform, which is a key revenue driver for the company.
Now what
These stocks have all fallen sharply over the last year or two as interest rates have jumped and valuations have come crashing down in the tech sector. As signs of a recession increase, there’s no reason for investors to expect their connection to macro-level news to disappear.
However, there is a silver lining. If a recession does hit, the Fed is likely to lower interest rates, and stocks like these figure to be early winners in the recovery.
Timing that is impossible, but tech investors should keep an eye on interest rates and macro-level news as it’s clear the sector is still sensitive to the threat of a recession.