What happened
After a rocky end to 2022, the enterprise is back. Many stocks that cratered last year on fear that companies would cut back spending have risen this year as the tech environment turned out better than expected, and even artificial intelligence gave stocks a little boost.
According to data provided by S&P Global Market Intelligence, Microsoft (MSFT 1.82%) is up 43.9% year to date as of the close of trading on Friday, Atlassian (TEAM -9.56%) has jumped 39%, and Cloudflare (NET 1.44%) is up 47.2%.
Image source: Getty Images.
So what
Cost cutting was the theme to start 2023 in anticipation of an economic slowdown that many economists were predicting. Microsoft cut 10,000 jobs, Atlassian laid off 500, and Cloudflare eliminated 100 sales jobs.
The moves were intended to reduce operational risk, given the anticipated economic slowdown. And investors were rewarding companies who cut costs, so layoffs were widespread in the tech industry.
While management teams were preparing for a recession, the recession never came. U.S. GDP rose 2% in the first quarter, and it doesn't seem that a recession is imminent, given low unemployment and improving inflation. So companies cut costs and business went on as usual, which should lead to better margins in the second half of the year.
As a further boost, artificial intelligence has been the hottest topic in investing this year. Microsoft has clearly been a beneficiary through its investment in OpenAI and partnership with the company on Bing's AI products. But Atlassian has added AI tools, and Cloudflare is an infrastructure partner of ChatGPT's. So, it's possible AI is a tailwind for all three companies.
Now what
It didn't hurt that the market likely oversold some of these stocks in 2022 as most software-as-a-service (SaaS) stocks dropped like a rock. But the bounceback has been swift and widespread.
What we haven't seen yet is most of the impacts of both cost-cutting and AI on the industry. First-quarter results indicated that there was a lot of interest in AI, but how that manifests on the demand side isn't yet clear. And cost cuts haven't worked their way through the financials yet either, with severance costs masking potential operating cost reductions.
We will see the impact of both cost cuts and potential new demand as the year goes on, but the market is definitely putting a lot of emphasis on the potential improvement on the bottom line.
MSFT PS Ratio data by YCharts
Until we see improvement on the bottom line, it's important to keep in mind that most of the movement in these stocks this year is just from margin expansion. That trend can reverse as quickly as it started, so earnings, which start to come out next week, will be critical for the tech industry.
