Strong beats and guides for most, with good supply demand dynamics, point to a solid 2021

So far this earnings season, many U.S. technology companies have delivered strong beats and guides, supported by continued recovery in the automotive and industrial end markets and a solid 5G smartphone cycle. Accelerating hyperscale capital spending will add strength to the demand environment in the first quarter after a two-quarter pause, as will ramping-up of 5G network deployments. This comes while critical components are in short supply, industry capacity utilization is running high, and inventories have been drawn down.

We see these conditions continuing to support strong demand in 2021, particularly for semiconductor firms, as inventories are rebuilt and semiconductor makers buy wafer fabrication equipment to expand capacity.

This comes against a backdrop of falling coronavirus cases after the holiday surge in western countries, a Chinese market that has already returned to pre-pandemic performance for multiple quarters, COVID-19 vaccine rollouts, and expectations for more federal stimulus in the U.S. For our full view on the tech sector in 2021, see "Industry Top Trends 2021: Technology", published on Dec. 10, 2020.

Intel's strategic pivot should allow it to stem share losses, but it will take time

Intel Corp.'s execution missteps with 10- and 7-nanometer nodes created an opening for Advanced Micro Devices Inc. (AMD) to take share in the PC and data center markets. In addition, the delays pushed Apple Inc. to design its own Advanced RISC Machines (ARM)-based processors for its Mac products, and hyperscalers are designing their own server chips, shrinking Intel's market opportunity. We view favorably Intel's plan for a hybrid approach, using outsourced manufacturing to get products to market quicker and stem share loss, while also investing to reestablish its manufacturing advantage. We believe this will allow it to maintain its dominant market position.

But this strategy comes with significant execution risk. There is no guarantee Intel can catch up to Taiwan Semiconductor Manufacturing Co. Ltd. and Samsung Electronics Co. Ltd.'s process technology leadership, and it will likely take multiple years to yield results. In the meantime, share loss is likely to continue over the next two years, albeit at a slowing pace as each incremental gain will be more difficult for AMD to achieve. We also like Intel's announcement of new CEO Pat Gelsinger, who we think will foster a return to its engineering roots and bring much needed credibility to the product roadmap. This would be in a similar vein as Satya Nadella taking the reins at Microsoft Corp., adding credibility to the company's hybrid cloud strategy.

For more details, see our report on Intel's manufacturing strategy, "Chipping Away At Intel Corp.’s Manufacturing Strategy And Credit Risk", published Jan. 25, 2021, and our report about the pros and cons of insourcing and outsourcing, "In And Out: Computing The Impact Of Apple's Chip Insourcing, Intel’s Outsourcing", published Jan. 13.

Hyperscale spending growth will be back in the first half after two quarters of digestion

We think hyperscalers are poised to accelerate spending on their data centers after a two-quarter slowdown, to support their strong revenue growth. The pandemic has accelerated the shift to the cloud. We expect this pattern of brief pauses followed by accelerating investment to play out over the foreseeable future. Digestion periods are not likely to last more than a couple of quarters because the players must invest to keep up with their very fast growth at large scale.

We see Microsoft gaining share as a key facilitator of hybrid and multicloud with Azure revenues increasing 50% year over year in the fourth quarter against Amazon.com Inc., which continues to offer the broadest set of capabilities and still expanded a robust 28%. Google LLC disclosed a negative 32% operating margin for the first time, pointing to investments in sales, engineering, and infrastructure ahead of revenues, which will likely take years to turn positive.

Strong 5G smartphone upgrade cycle leads to network investments ramping up

Apple's 5G phone rollout was a great success in the fourth quarter, and we expect this strength to support an upgrade cycle in 2021. Samsung will also benefit. This cycle will be very good for suppliers since 5G phones have higher silicon content. Network upgrades are accelerating to support wider adoption of 5G phones, with Japan and Korea furthest ahead, followed by China, the U.S., and finally Europe. We see Ericsson picking up share from Huawei, particularly in Europe.

The investment cycle should last several years given reliance on short wave spectrum that requires more connection points. Enterprise and industrial use cases will be key to unlocking return on investment beyond smartphone services.

Automotive and industrial cyclical recovery continues

The auto and industrial recoveries continue apace, with auto stronger given that its second-quarter trough was deeper. The recovery is so strong that it's causing a component shortage that is limiting global auto unit growth. We expect supply to be tight for the next couple of quarters, which should benefit suppliers. China's quick recovery has supported the industrial market. We expect significant year-over-year growth for both markets in the first half given that China's GDP trough was in the first quarter of 2020 while the western world's was in the second.

Enterprise is the laggard, but the macroeconomic recovery portends more spending

Following rapid retrenchment amid the pandemic, enterprises have not brought spending all the way back outside of pockets of strength in cloud, collaboration software, and PCs. We think this market should loosen up as management teams gain confidence in a strong recovery in aggregate demand, supported by sharp drops in virus cases following the holiday surge and vaccine rollouts. We expect security to be a top priority given that the pandemic has increased the attack surface. Network connections have proliferated and new threats abound, evidenced by the SolarWinds Holdings Inc. hack.

Strong PC demand should persist in the first half given continued work-from-home arrangements and long lead times. But it's likely to wane in the second half against tough comparable periods and as enterprises have pulled forward PC investments. This strength caused us to raise our 2021 estimate of global PC shipments to 0% from negative 7%. See "2021 Global PC Shipment Forecast Raised To 0% From -7% Following Strong Expected Results In The Fourth Quarter Of 2020", published Jan. 14.

DRAM about to inflect, and NAND setting up better than feared

Demand fundamentals are strong for both DRAM and NAND with a refresh cycle in smartphones and gaming consoles, accelerating hyperscale investments, and improved enterprise spending on servers. DRAM supply has been more disciplined, so we expect firm pricing in the first quarter. We still expect NAND pricing to be weak in the first half, but it is turning out to be better than feared because Samsung may be scaling back planned investments.

Ratings may be positively affected

S&P Global Ratings took negative rating actions (mostly outlook revisions) on nearly a quarter of our rated technology portfolio in 2020, especially during the second quarter, as the COVID-19 pandemic created significant uncertainty regarding the information technology spending environment. Rating actions were more balanced through the second half as certain issuers benefitted from an accelerated digital transformation to the cloud and pick-up in work-from-home related hardware.

Given the positive demand and supply dynamics heading into 2021 as well as improving macroeconomic fundamentals, we believe there is upside risk to our view of technology spending will improve, which could portend positive rating actions through 2021.