After a white-knuckle summer, is the tech bubble about to burst?
By Boring Money
22 Oct, 2024
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It has been a rollercoaster few years for the tech sector, to say the least. Against the bustling backdrop of the artificial intelligence (AI) boom, tech stocks have been making headlines and history, attracting unprecedented attention from investors the world over.
Success driven by select few super stocks
The hype is not unwarranted, however. Technology stocks alone have generated 32% of global equity returns and 40% of US equity market returns since 2010. Earnings per share have risen about 400% from their peak before the financial crisis, while all other sectors combined have increased just 25% over the same period.[1] Meanwhile, more than 200 AI startups globally are unicorns – meaning they’re valued at $1bn or more.[2]
However, the recent surge in returns can largely be attributed to a select group of US stocks – the so-called Magnificent Seven (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta and Tesla) - leading the pack in AI innovation.
Peter Oppenheimer, Chief Global Equity Strategist and Head of Macro Research in Europe, at Goldman Sachs, explains how this elite group of tech firms have been able to rise to the top:
“The drivers of this success have reflected their ability to leverage software and cloud computing and to fuel high profitability generated by extraordinary demand growth. But their more recent surge in performance since 2022 owes much to the hopes and aspirations around AI. Despite continued powerful earnings growth, valuations have been rising, led by an increasingly narrow group of 'hyperscalers’”.[3]
Indeed, the Magnificent Seven stocks are the same size as the entire stock markets in the UK, Canada, and Japan combined.[4] Analysis from Deutsche Bank found the combined profits of the seven companies exceeded almost every G20 country in 2023.[5] The sheer size of these companies means they have a disproportionate impact on the returns of various indices that track them, such as the S&P 500 and the Nasdaq.
These companies were already at the top of the pack in the last technology wave - notably for contributions to software and cloud services - and their scale and profitability put them in a unique position of being able to absorb the high cost of AI investment.
This has led to criticism that the sector is approaching bubble territory – not unlike the infamous “Dot-Com Bubble” that burst around the turn of the millennium. However, the buzz around AI - whilst loud and eye-catching - is in fact masking some weaker results in other pockets of the tech sector.
“When you look at technology outside of AI, there’s not that much happening. Many [sub]-sectors are still in a recession. The only thing that has been really growing has been AI,” says Tony Kim, Managing Director, Lead Portfolio Manager and Head of the Global Technology Team at BlackRock.[6]
Corroborating this statement, Brice Hill, Chief Financial Officer at semiconductor chip supplier Applied Materials adds: “We’re seeing particularly strong pull related to AI and data centre computing [but there are] pockets of weakness in the auto and industrial end-markets".[7]
Dig even deeper and recent reports indicate the majority of large tech companies have been growing more slowly than in the past, while many smaller ones are actively shrinking. Groups in the S&P 500 IT sub-index increased revenues by an average of just 6.9% over the past 12 months, according to Bloomberg data, compared with a five-year average of 10%. About three-quarters of companies grew more slowly than their recent average, and earnings per share increased by an average of 16% in the past 12 months, down from 21% over the past five years.[8]
This weakness is even more evident in small-cap indices, where there is no boost from mega-cap firms like the Magnificent Seven. In the Russell 2000, technology was the second-worst performing sector in terms of revenue growth in the second quarter, according to data from LSEG (London Stock Exchange Group). Revenue fell 6.1% year on year, while profits were down 2.8%.[9]
Ted Mortonson, tech strategist at RW Baird, explains: “Generative AI is masking a cyclical downturn in a lot of other core sectors. Everyone is hoping things get better in the next few quarters, though hope is not an investment strategy”.[10]
Shaky summer performance poses important questions
During the summer, volatility in the sector saw the Nasdaq fall over 13% between July and August, while the S&P 500 Information Technology index similarly slipped over 16% in the same period.[11][12]
This was driven by a combination of factors, including disappointing earnings results as well as brewing concerns over the outsized influence of the Magnificent Seven stocks on global markets.
There is also ongoing anxiety that the AI boom driving huge demand for specialised chips has been over-egged and resulted in artificially inflated valuations for some of the key players.
For example, Intel - one of the US’s best-known chipmakers – saw its shares tumble about 30% in August after it unveiled plans to cut 15,000 jobs as part of a sweeping restructuring plan.[13] Chief chipmaker Nvidia, which briefly became the world’s most valuable company in 2024, also saw its shares fall more than 26% between July and August.[14]
In another gloomy signal for the sector, Warren Buffett’s Berkshire Hathaway cut half its stake in Apple as part of a broader shift away from equities that led the billionaire investor to offload $76bn of stocks in one go.[15]
Though the technology sector has made a modest recovery since its late summer blip – the Nasdaq is up more than 13% since its August nadir and S&P 500 Information Technology is up nearly 16% at the time of writing – the recent volatility has raised important questions about tech’s resilience and lack of diversification.[16][17]
“With markets being increasingly dependent on the fortunes of so few, the collateral damage of stock-specific mistakes is likely to be particularly high,” Oppenheimer warns.“A market that becomes dominated by a few stocks becomes increasingly vulnerable to either disruption or anti-trust regulation. Even companies that have enjoyed near monopoly power in the past have ultimately succumbed to these pressures”.[18]
This makes the sector a deceptively tricky area to invest in. Recent headlines lauding the success of Nvidia and other AI-focused firms make it seem like an easy “win”, however increasing concentration in the mammoth stocks that make the news masks how the canyon between the winners and losers seems to be growing ever larger.
“There will be volatility as investors try to figure out which companies will win, which will be disrupted, and what it's all likely to mean for their businesses and share prices,” says Adam Benjamin, Manager at the Fidelity Select Technology Portfolio.[19]
This makes a compelling case for active management when investing in tech, where experts in the field can apply their expertise in identifying real growth opportunities - and not just blindly following the crowd.
AI remains a future-proof investment opportunity
Despite a less-than-stable summer, the tech sector remains one of the most relevant and exciting investment opportunities as we approach 2025.
In the nearer term, the upcoming US election has the potential for knock-on effects, in part due to the outsized influence of the megacap tech stocks based in the US. Ben Rogoff, Lead Manager at the Polar Capital Technology investment trust, says the sector is likely to prefer a Democrat victory – although the jury is still out on which party will actually win in November.
Rogoff says: “In terms of outcomes, in the end we are in the investment business. However, it is probably fair to say that the tech sector would prefer a Harris win and continuity of sorts: less geopolitical risk, primarily as it relates to Taiwan, where most of the leading-edge wafers are made today – and that manufacturing capability is core to the AI story”.
Looking out further, we return to the discussion around whether the hype around AI is genuinely sustainable, or if it is approaching overblown territory. Alastair Unwin, Deputy Manager at Polar Capital Technology, maintains that AI is really only just getting started. He says that in 2025 and beyond, this subsector will continue to demonstrate its enduring relevance and potential:
“While we understand fears that AI excitement will fade, we believe the opposite is true and that the longer-term potential of this highly disruptive technology will become much more visible as 2025 progresses”.[20]
Unwin's view is shared by Reid Menge, Managing Director and Portfolio Manager of the Global Technology Team at BlackRock: “AI is here to stay and we’re only at the tip of the iceberg in terms of the investment opportunity”.[21]
All this being said, the team at BlackRock urge investors keen to invest in tech – or increase their exposure – to consider the active route to help identify the next generation of tech superstars.
“In all, we believe the rapid evolution of AI and all of its ramifications makes investing in this space very much an active pursuit,” says Kim. “Volatility such as that seen of late, while always unsettling, is not unexpected and could present buying opportunities in this exciting and, we believe, enduring theme”.[22]
Polar Capital also caution that the risk of volatility in this rapidly-evolving sector makes active management a sensible route for investors unfamiliar with the scene.
“We continue to believe AI will reshape most industries and potentially redistribute existing profit pools, while large new markets/opportunities will emerge as with earlier general-purpose technologies. However, as we have said before, the early stages of new technology cycles are often punctuated by intense periods of increased risk aversion/volatility in an uptrend,” Rogoff explains.[23]
“This is especially true in the months ahead of US elections and/or during periods of increased economic uncertainty. The next few months may be noisy in terms of macroeconomics and geopolitics, with further volatility to be expected. Nonetheless, AI expectations are now much healthier and we expect to enter 2025 with greater economic clarity, allowing the broader impact of Al (and associated investment opportunity) to become significantly more visible”.[24]
All in all, however, the sentiment remains that AI is very much here to stay and still represents an exciting growth opportunity for investors keen to capitalise on its advancement.
“In our 25+ years as technology specialists, we have certainly not experienced a technology shift as exciting as we see unfolding today. If history is a guide, almost all industries will be reshaped by AI (and existing profit pools redistributed) while large new markets/opportunities will emerge (impossible to predict let alone size at this early stage,” says Rogoff.[25]
“Understanding the impact of AI may be the most important factor investors have to consider this decade and we are hopeful that lessons from previous technology cycles could provide a blueprint for capturing much of the AI growth opportunity and navigating the disruption ahead”.[26]
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[1] Goldman Sachs, September 2024
[3] Goldman Sachs, September 2024
[7] Financial Times, September 2024
[8] Financial Times, September 2024
[9] Financial Times, September 2024
[10] Financial Times, September 2024
[11] Google, October 2024
[12] Google, October 2024
[13] The Guardian, August 2024
[14] Google, October 2024
[15] Financial Times, August 2024
[16] Google, October 2024
[17] Google, October 2024
[18] Goldman Sachs, September 2024
[20] Polar Capital Technology, August 2024
[22] BlackRock, September 2024
[23] Polar Capital Technology, July 2024
[24] Polar Capital Technology, July 2024
