Why the Digital Economy sector still warrants a spot in your portfolio

Key Points

• Technology software industry is well position to navigate the uncertainties, given stronger consumer base, high recurring income and beneficiaries of AI adoption.
• Tech-enabled sectors such as digital advertising and online retails could face mixed impact, but larger companies should be more resilient.
• The direct impact of tariffs on the digital economy remains limited, with key categories like semiconductors and consumer electronics still exempt. However, the broader economic slowdown may weigh on sentiment and growth
• Technology hardware industry could face higher headwinds, as many of their supply chains are sourced overseas, such as China.
• In light of these near-term headwinds, we are revising our growth estimates for the digital economy sector downwards. However, we maintain a 4-star “Very Attractive” rating, with a clear preference for Big Tech, which we believe is at the forefront of the AI race.
• The ongoing tariff uncertainty, particularly the steep tariffs between the US and China, is expected to weigh on global growth and continue exerting upward pressure on US inflation.

Technology Software: Relatively resilient during uncertainties 

The software sector has limited direct exposure to China, and most companies within the space are largely insulated from tariffs due to their minimal reliance on physical goods or manufacturing. While it is common for businesses to scale back IT spending during periods of economic uncertainty, potentially resulting in slower growth, we expect the overall impact on sales growth in this sector to be relatively mild compared to others. Indeed, the sector could still achieve double-digit growth over the next two years. Below is the breakdown of what could be the impact of the tariff (directly and indirectly)

Consumer Base: Many software companies—particularly the larger ones—benefit from a highly diversified customer base, with large enterprises accounting for the majority of sales. We believe providers with significant exposure to small- and medium-sized businesses (SMBs) are more vulnerable to tariff-related disruptions, both directly and indirectly, and are therefore more likely to see downward revisions to their sales growth estimates. In contrast, larger cloud service providers (CSPs) such as Microsoft and Oracle cater predominantly to large enterprises, which positions them to weather economic slowdowns better than peers with heavier SMB exposure.

Revenue structure: Firms generating a significant portion of income from recurring or subscription-based revenues are better positioned to withstand market volatility. This revenue model provides a more stable and predictable cash flow than companies reliant on new sales. For example, Microsoft’s revenue is largely recurring, driven by cloud services, software subscriptions, and long-term enterprise licensing agreements. Similarly, over 70% of Oracle’s revenue is now recurring or renewable, including maintenance services, enhancing its financial resilience.

Balance sheet: We believe the technology sector is better equipped to outperform other sectors in the face of economic headwinds stemming from tariff uncertainty. The sector boasts one of the highest levels of free cash flow per share across all industries, with the "Magnificent Seven" tech giants leading by a considerable margin. Additionally, the sector maintains one of the strongest cash-to-total-debt ratios, which reflects a robust credit profile and provides further financial flexibility during turbulent periods.

Figure 1: Tech sector has higher cash-to-debt ratio

AI Exposure: We believe that in the event of an economic slowdown, businesses are likely to prioritise their AI-related spending over non-AI expenditures as AI is viewed as a way to automate processes, reduce costs, and improve efficiency—crucial in times of tightening budgets. Companies see AI investment as a long-term enabler, not just discretionary tech. Firms worry that cutting back on AI will cause them to fall behind competitors, especially in fast-moving industries. Software companies stand out as key beneficiaries of AI adoption, although we may observe some compression in non-AI cloud consumption should firms scale back on their overall IT budgets.

Despite some recent signs of caution, Big Tech companies such as Google, Oracle, and Meta remain firmly committed to their AI capital expenditure (CAPEX) plans for 2025, with Meta even revising its CAPEX projection upward for the year in its latest earnings report. Although reports suggest that Microsoft and Amazon have slowed or paused certain data centre expansion projects, both companies have kept their full-year CAPEX guidance unchanged.

This trend is further validated by recent earnings from global software leader SAP, which reported a 58% year-on-year increase in operating profit for Q1 2025. SAP attributed this strong performance to surging demand for its cloud-based offerings driven by AI, and also reaffirmed its full-year outlook for cloud revenue, underscoring the tangible business impact of AI integration. Other CSP giants also reported a similar trend, with Microsoft reporting strong earnings growth in its cloud business along with the robust outlook for the coming quarter despite the ongoing tariff concerns.

On the hardware side, semiconductor giants such as TSMC have maintained a bullish outlook, citing continued robust demand for AI applications. The company noted that it had not yet seen any changes in customer purchasing behaviour, despite the backdrop of heightened tariff uncertainty. This sentiment is echoed by Nvidia, whose latest update showed that while overall growth has moderated, demand for its next-generation Blackwell chips remains strong.

We anticipate that demand for AI, particularly in the form of large language models (LLMs), will prove to be more resilient during economic downturns, as AI becomes increasingly embedded in daily life and enterprise workflows. In February 2025, OpenAI reported that its monthly active users (MAUs) surpassed 400 million, which is approximately 10.6 times that of the next leading LLM provider, DeepSeek.

Despite a paid user penetration rate of less than 5%, OpenAI still forecasts USD 12.7 billion in revenue for 2025, more than triple its 2024 figure of USD 3.7 billion. Such growth could provide a critical revenue uplift for LLM providers, especially in a challenging macroeconomic environment where other segments may face headwinds.

Table 2: User growth momentum for OpenAI remains robust despite increasing number of competitors

Table 3: Software Sales, Margin Indirect exposure

Tech-enabled: Growth headwinds could rise, stay selective

Digital advertising: Digital advertising companies could face increased risk as escalating tariff tensions may lead to a reduction in brand advertising expenditure, driven by heightened uncertainty. Given the discretionary and variable nature of advertising budgets, businesses are generally more inclined to scale back ad spending in uncertain economic conditions.

Smaller advertising platforms, such as Snap and Reddit, which have greater exposure to the retail sector, may experience a more pronounced impact on their sales. In contrast, larger players like Meta and Alphabet may be better positioned to withstand these challenges, owing to their ability to leverage large language models (LLMs) to enhance ad targeting and optimisation. However, this could result in cannibalising ad-click growth across platforms as competition intensifies.

Meanwhile, Amazon’s advertising business may prove more resilient than others, as its ad spending is directly linked to sales performance. Many sellers on the Amazon platform are less likely to reduce their advertising budgets, given that doing so could have a direct and immediate impact on their revenue.

Figure 2: Digital ads revenue expected to grow slower due to tariff impact

Online Retail: The growth outlook for online retail companies may face headwinds as higher prices emerge across marketplaces following the recent US tariff announcements and the intensifying trade tensions between the US and China. Sellers are likely to experience pressure on margins due to increased input costs. Should they choose to pass these costs on to end consumers, rising prices may dampen consumer demand.

Companies such as Shopify may come under greater pressure given their significant exposure to small- and medium-sized businesses, which are generally more vulnerable during periods of economic downturn. While larger players like Amazon are similarly affected by tariff-related cost pressures, their scale provides greater pricing leverage with suppliers.

Moreover, Amazon may be positioned to gain market share through the potential removal of the de minimis exemption, which would reduce the competitive advantage of low-cost cross-border rivals such as Shein and Temu, who have eroded Amazon’s market share in recent years. This shift could help partially offset the impact of tariffs on Amazon’s business.

Broader digital economy sector continues to perform. Overall, while the digital economy sector is not spared the negative impact of Trump’s tariffs, the effect is expected to be uneven—companies in the software industry are likely to be least affected, followed by those in tech-enabled services and then technology hardware. We believe the digital economy sector is better positioned to weather the challenges more resiliently than other sectors, owing to its strong balance sheets and robust earnings growth estimates that help cushion any adverse effects. The sector is set to experience one of the most robust earnings growths compared to other sectors, and this could serve as a strong buffer towards corporate performance.

Figure 3: Strong earnings growth estimates could help buffer macro headwinds

Long-term optimism on AI still remains firm

While current macroeconomic headwinds may introduce continued volatility in the stock market, our long-term outlook on artificial intelligence (AI) as a fundamental growth engine for Big Tech remains unchanged. We believe the rapid evolution and adoption of AI technologies are at the early stages of a multi-decade bull run. Amid shifting global dynamics, AI stands out as a consistent and transformative force, reshaping industries, unlocking productivity, and driving both top-line and bottom-line growth across sectors.

Already, we are witnessing a transition from generative AI tools that rely on human prompts to more advanced autonomous AI agents capable of reasoning, making decisions, and solving complex, real-world problems independently. These capabilities are increasingly being customised to meet the diverse needs of enterprises across various industries, accelerating adoption.

AI as a structural investment, like digital infrastructure, rather than cyclical spend like marketing or travel. We believe that technology companies will be one of the primary beneficiaries of this AI boom, given that they have the infrastructure, the platform, the data advantage, the talent and high R&D capital. More specifically, big tech firms will be the direct beneficiaries due to their large CAPEX spending and wider customer base, allowing a smoother rollout of AI features.

Technology Hardware: Apple’s recent launch of Apple Intelligence demonstrates how hardware companies are embedding AI capabilities natively into their devices. From on-device large language models (LLMs) to personalised assistants and real-time contextual recommendations, AI enhances user experience, device performance, and customer stickiness—driving long-term hardware demand and ecosystem engagement.

Technology Software: AI enables platforms to become more intelligent, predictive, and automated. Whether it's AI-powered analytics, smart workflows, or natural language interfaces, software vendors can now deliver more value-added services, helping enterprises reduce costs, improve decision-making, and accelerate innovation. CSP could also benefit as more companies choose to run their AI workloads on the cloud.

Tech-enabled: In tech-enabled industries such as digital advertising, AI revolutionises how platforms target and engage users, allowing companies like Google and Meta to deliver more personalised and effective campaigns, leading to improved return on ad spend (ROAS) and increased advertising revenue.

Figure 4: Companies’ profitability has improved since the emergence of ChatGPT

Digital Economy Remains Our Top Pick — Preference for Big Tech

The AI narrative remains structurally compelling, but near-term challenges are emerging as businesses scale back on certain expansion plans and adopt a more cautious stance on spending amid ongoing tariff uncertainties. In response to these headwinds, we are revising our short-term growth outlook for the digital economy sector downward.

Despite this, we maintain a 4-star “Very Attractive” rating, with a clear preference for Big Tech leaders. These companies continue to dominate the AI race, supported by strong balance sheets, robust cash flows, and deep competitive moats, positioning them well to navigate market volatility.

The broader digital economy stands to benefit from the continued advancement of AI, with strong earnings momentum and order backlogs offering a buffer against macroeconomic softness. Based on a fair price-to-earnings (PE) ratio of 30x, this suggests an upside potential of 7.91% for the Invesco NASDAQ Internet (NASDAQ: PNQI) ETF. For Unit Trusts, we recommend the Eastspring Investments Unit Trusts - Global Technology SGD and Fidelity Global Technology A-ACC-USD. 

While heightened volatility and the risk of further market pullbacks remain, we encourage investors to take advantage of any sell-offs as buying opportunities.

Table 4: Valuations table for Nasdaq CTA Internet Total Return Index