Technology Update: ‘Is the Tech AI Trade Fading?’

By Daniel Morgan, Synovus Trust Senior Portfolio Manager

Does a current rally in the Tech Sector (S&P Information Technology Sector Index plus-34.6 versus S&P 500 Index up 22.5% YTD) have legs? Or will the recent Tech share increases fade once macro factors — like slower economic growth and a possible AI letdown — impacting the market come to shore? There are a couple of driving forces that are propelling the Tech sector beyond just AI enthusiasm.

Consensus EPS estimates for Fiscal Year (FY) 2024 call for profit growth in the Technology sector to rebound  to being up 16.4% Year-over-Year (YoY). With the biggest recovery in FY2024 growth expected to come from the Semiconductor and Software and Services segments, estimates are expected to increase to 41.8% YoY and 10.4% YoY growth, respectively. Working into the upcoming 1Q25 Technology reporting season, expect profits to grow 20.1% YoY, with semiconductors leading the pack and expected to post growth of 71.5% YoY.

Source: Bloomberg “Expected Earnings Growth for Industries in S&P 500”

In the past, the Tech sector has been trading in unison with the Federal Reserve as fears that the current tightening policy will eventually lead to slower economic growth, squeezing IT budgets and resulting in lower profits for the Technology sector! Recent economic reports have pointed to a slowing but more resilient economy — 3Q GDP plus 2.8%, Core CPI 3.3% and nonfarm payrolls 254,000 — than expected.

The “No Landing” scenario appears to be winning out. The Fed has already begun to ease, despite inflation north of the “2% line in the sand.”  Overall, the markets are viewing the Tech sector’s strong profit growth and massive cash balances as a safe haven as compared to the other sectors. The Tech space has been buoyant — with social media and internet ad spend rates — exhibiting a spending bounce back after the COVID-19 slowdown. With sectors like IaaS datacenter and semiconductors, overall growth has accelerated due to AI investments.

Is the AI trade within Tech starting to fade as capital expenditure (CapEx) concerns mount? AI mentions in news stories appear to be plateauing, with a subtle shift in CapEx underway. For a period of time, the AI narrative was being driven by this circular CapEx story at the top of the market, given that one firm’s CapEx is another firm’s revenue. While the AI craze is alive and well, it’s difficult not to notice how mentions of AI in news stories are cooling off, albeit at elevated levels. At the same time, it’s important to be mindful that there is a subtle shift occurring in where tech companies are targeting their CapEx more toward Power Generation. Will the monster CapEx budgets announced by the hyperscalers yield the ROI that investors will demand to drive Tech stocks higher? With the top players (Amazon, Google, Meta and Microsoft) projected to spend collectively up to $180 billion in AI CapEx in 2025, most will fail but a few will also succeed. It’s too early to say if companies are going to cut back their AI tech spend, but it’s possible the largest portions are behind us, at least for now.