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Considering that we may be in the later stages of the economic cycle, we wanted to highlight the Software and Services subsector for investing within the Technology sector. We believe that Software and Services stocks offer several advantages over other Technology stocks. First, software companies are increasingly migrating towards recurring-revenue business models in which customers sign multiyear subscription deals and pay for software licenses on a monthly basis. These contracts help improve visibility into future results and tend to make software profits more predictable than other technology subsectors.
We also view the subsector favourably because many companies provide services and capabilities that enable essential business functions, such as ecommerce and payment processing, or enable customers to conduct business online. As a result, we feel that results are not as heavily influenced by economic slowdowns as other Technology stocks. In addition, investment in software continues to rise and is attracting an increasing portion of total capital spending. In light of current trade tensions between the U.S. and China, we feel that Software and Services stocks are less susceptible to tariffs and other trade actions. Software companies do not have manufacturing and component supply chains that can likely be impacted by tariff actions. Sales of software products into China, however, could be susceptible to Chinese tariffs.
Historically, Software and Services stocks have tended to outperform the overall market in both strong economies and during economic downturns, as illustrated in the chart above. We note that the stocks in the sector have declined in recessions but have tended not to drop as much as the overall market, likely because financial results have not fallen as much as that for companies which are more sensitive to economic cycles. Risks to investing in the Software and Services subsector include significant competition, a rapid pace of technological change, results that are impacted by a slowing economy, and volatile stock prices.