How to navigate the stock market’s ‘new normal’ after the last 2 decades of investing became ancient history

It was an era of “free money” that helped enable a “growth at all costs” mindset among many companies, particularly in the tech sector.

Near-zero interest rates and quantitative easing (QE)—a central bank policy of buying mortgage-backed securities and government bonds in hopes of spurring lending and investment—reduced the cost of borrowing, allowing growth rates to take center stage.

From ride-hailing leaders like Uber to artificial intelligence darlings like Palantir, profitability in the tech sector has largely been an afterthought over the past decade, but now, times are changing.

Federal Reserve Chair Jerome Powell has said that he will continue to increase interest rates until there is “clear and convincing evidence” that inflation, which remains near four-decade highs, slows. 

And QE? It’s now a thing of the past, at least for the time being. After 29 months of consistent large-scale asset purchases that drove the Fed’s balance sheet to unprecedented levels, and, again, helped stimulate the economy during tough times, it all came to an end on March 11.  And just this week, the Fed began the difficult process of shrinking its balance sheet, leaving markets effectively on their own.

Sanjay Brahmawar, the CEO of the enterprise software firm Software AG, told Fortune that this new economic environment will lead to a shift for tech firms away from the “growth at all costs” mindset of the past decade and towards a “growth with profits” outlook.  

“For years companies have said, let’s just keep growing and we’ll figure out profitability somewhere down the road,” he said. “I think that’s not going to be acceptable anymore. Everybody’s going to want to know, where’s your brand’s path to profitability? Show me when you will start making some money.”

In this new, more profit- and efficiency-focused era, there will be a number of challenges for once high-flying tech stocks and startups, but some tech companies will remain good investments. Investors just have to be more selective.

“I think it’s a high-risk environment, and you’re going to see risk coming off the table,” Wedbush’s Dan Ives told Fortune. “It’s a new normal, and I view it as a Darwinian example of why you want to own the winners in what I see as a bifurcated market.”

A new normal for tech firms

Software AG’s Brahmawar laid out a few key strategies that he believes tech CEOs will follow in this new environment.

First, many tech firms will likely shift their focus to ensuring they earn a return on big expenditures, while emphasizing “mission-critical” software like API management or hybrid integration. Brahmawar says that as his clients’ cost of borrowing increases, their operating expenses follow suit, leading them to “think more carefully about where they spend their money.”

Inflation is also leading to changing behavior in the tech space as increasing employee salaries put pressure on companies’ bottom lines, he said. The U.S. dollar inflated at an average annual rate of just 1.7% from 2010 to 2020, as measured by the Consumer Price Index (CPI), but in April, the figure hit 8.3%.

“And how do you deal with that [inflation]? Well, part of it you can pass on to your clients in terms of your pricing, et cetera, but another part you can’t, and therefore you need to go back into your efficiencies and look for more gains,” Brahmawar said.

The CEO believes mergers, acquisitions, and consolidation in the tech industry will likely increase due to falling public and private valuations that make companies cheaper to buy. And business-to-consumer (B2C) companies will face more challenges than most in the tech sector moving forward, especially if consumer spending contracts, he added.

Subscriptions in the business-to-business space differ from consumer-facing models, which could help enterprise-focused firms outperform the rest of the tech sector, Brahmawar explained.

“We don’t have these subscriptions where every month you can just cancel; it’s a three-year contract,” he said. “So it’s sticky business, which means customers don’t just step away like they can in a B2C environment.”

Additionally, the business-to-consumer space is where the “growth at all costs” mantra has been most prevalent over the past decade, he argued, which could mean that stocks in those companies will likely be more volatile.

For investors, it’s all about the haves and have-nots

When it comes to investing in the tech sector, there are some areas that experts say will be more likely to outperform in this new environment.

“There are certain bellwether technology companies that are in a better position than others,” Jon Maier, chief investment officer of fund management company Global X ETFs, told Fortune. “So ones that are less reliant on capital markets, ones that have the ability to maneuver their supply chains, and ones that can potentially pass through [higher] costs to the end user. Those are the types of tech companies that can withstand higher-interest-rate environments.”

Maier has noticed that investors in his company’s ETFs have been “repositioning” from tech-focused investments into “high-quality” companies, firms that offer dividends, and the energy sector.

Wedbush’s Ives also argues that certain tech stalwarts, like Apple and Microsoft, will outperform “smaller niche competitors” over the coming years, while companies that have yet to reliably turn profits “could be hurting.” He recommended that investors look for tech firms with strong cash flows that operate in “pockets of strength.”

“Enterprise [technology], cloud [computing], and cybersecurity are holding up like the rock of Gibraltar, and even in a softer macro [economic environment],” he said. “So I think you’ve got to compare the haves and have-nots relative to this economy. And that’s why you cannot paint them all with the same brush.”