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The enthusiasm for artificial intelligence masks weakness in much of the technology sector. According to investors and evaluation of recent financial reports, many firms are “still in recession” after a slowdown that began in 2022.
Massive share price gains in major firms like Nvidia and Microsoft, which had been predicted to be early beneficiaries of AI, helped erase memories of a terrible 2022, when the tech-dominated Nasdaq Composite plunged by nearly a 3rd.
Beneath the surface, nevertheless, many technology firms that are usually not focused on AI are struggling to get back on the right track.
“If you have a look at technology outside of AI, there's not that much happening,” said Tony Kim, head of technology investing in BlackRock's fundamental equity division. “Many (sub)sectors are still in recession. The only thing that's really grown is AI.”
More traditional technology areas akin to software, IT consulting and the production of electronic devices for other industries akin to manufacturing and automotive have struggled, including weak demand and the fallout from overexpansion and excess inventory in the course of the coronavirus pandemic. Some have also suffered directly from the expansion of AI as clients with limited budgets redirect their investments.
Dustin Moskovitz, co-founder of Facebook and now CEO of Asana, summed up the situation for a lot of firms last week when the business software company scaled back its forecasts for the remaining of the 12 months.
“What we're seeing within the technology sector remains to be type of a regression from the overstaffing and overspending that we saw originally of the pandemic,” he told analysts. “And all of that comes with what I feel is tremendous uncertainty within the economic environment. And then there's the query of how AI goes to play out.”
Recent financial reports show that the vast majority of large technology firms are growing more slowly than up to now, while many smaller firms are actively shrinking.
According to Bloomberg data, firms listed within the S&P 500 IT sub-index increased their sales by a mean of 6.9 percent up to now twelve months, in comparison with a five-year average of 10 percent. Around three-quarters of the businesses grew more slowly than their recent average.
Earnings per share rose by a mean of 16 percent over the past twelve months. Over the past five years, the rise was 21 percent.
The weakness is more evident within the small-cap indices, where there isn’t any support from the mega-cap firms. In the Russell 2000, the technology sector was the second-worst sector by way of revenue growth within the second quarter, based on LSEG data. Revenue fell 6.1 percent year-on-year, while profits fell 2.8 percent.
“Generative AI is masking a cyclical downturn in lots of other core sectors,” said Ted Mortonson, technology strategist at RW Baird. “Everyone is hoping things will recover in the subsequent few quarters, but hope is just not an investment strategy.”
Even in sub-industries which were swept up within the AI craze, akin to semiconductors, some businesses are struggling. Brice Hill, chief financial officer of chipmaker Applied Materials, told analysts last month that “we're seeing particularly strong momentum in AI and data center computing,” but there's “weakness within the automotive and industrial end markets.”
“It's similar in all places on the economic side,” says John Barr, portfolio manager at Needham Funds, who has invested in several semiconductor firms, including Applied Materials. “The current growth is just not that great, so we search for firms which have a stable business and are investing in something latest.”
Investor enthusiasm for AI-focused firms has waned since early summer, leading many commentators to predict that investor attention will shift away from big technology stocks and toward sectors akin to financial services and industrials for an prolonged period.
Some technology experts are hoping for the same intra-industry rotation from the largest AI stocks to less popular areas of the industry. While few firms are forecasting triple-digit growth like Nvidia has in recent quarters, there are signs that among the worst-performing areas of the technology sector are turning a corner.
“I feel we're seeing a stabilization – the deterioration within the more macro-sensitive areas has stopped, and if rates come down, that may help,” said Tony Wang, portfolio manager of T. Rowe Price's science and technology fund.
“I feel like the concept that AI is the one thing that works has been around for 2 years. I'm undecided it would be around for the subsequent two years.”
