The recent round of technology results has revealed a growing gap between expectation and reality. Although most of the ‘Magnificent Seven’ squeaked ahead of analyst forecasts, few could deliver on the lofty hopes built into share prices, on AI, on digitisation, or on cloud computing – and results overall were mixed. Could this bring the market’s long-running love affair with the tech giants to a close?
Apple’s results were perhaps the most disappointing, with the group reporting a 1% fall in revenue as consumer weakness saw demand for MacBooks and iPads drop. Although earnings per share rose 13% on the back of a stronger performance from the group’s higher margin services business, investors were unimpressed.
Amazon saw stronger results, with Amazon Web Services, the cloud computing business, continuing to drive growth. Amazon (along with Microsoft) also appears to be taking a lead on AI, with a partnership with Anthropic and home-grown services also in development. Its ad revenue was strong. However, Alphabet’s figures failed to enthuse investors, with investors condemning the shares to their biggest single-day decline since March 2020 after results were announced.
While these results can hardly be called a disaster, a lot is expected from the technology and consumer giants. Investors would be asking fewer questions were these companies not notably more expensive than the rest of the market. Sheridan Admans, head of fund selection at Tillit says: “The Nasdaq [index] has been experiencing a rapid rise this year, and while it has pulled back over the last few months, it remains the standout performing index of the major indices such as the S&P 500, Topix, MSCI World, the China H index and the UK All-Share index, returning 30.6% year-to-date to the end of October in sterling terms. The next best-performing index, the S&P 500, has only returned 8.3% over the same period.”
There is a question over whether this might lead to a reappraisal of technology more generally. Investors have turned to it as a source of defensiveness, a source of growth, as well as to play trends such as AI. It has been the solution to every investment problem that has presented itself. However, Admans says: “It is unlikely to be this way forever. And there are some signs in the market that pressures for change are building.”
He adds: “Past periods of intense concentration in the market, such as in 2020 and 1999, where one dislocation affected the market, raise concern about this concentration continuing indefinitely and potentially leading to a correction.”
Willem Sels, global chief investment officer at HSBC Global Private Banking & Wealth, believes there are still some elements that should help drive the sector from here. He says: “The headwind for tech coming from rising rates should ease, as we believe the Fed is done hiking rates. As for earnings, the results from technology companies in the Q3 earnings season have been mixed so far, but we continue to believe that some structural forces will continue to support the sector.
“Notably, the digital transformation of our economies means that we are getting ever more data intensive, so the cloud should continue to see strong growth. Innovation through AI is creating real potential for productivity gains, so we expect corporate investment spending in technology to increase as we enter 2024.”
To diversify away from technology, investors are likely to need more confidence, says James Thomson, manager of the Rathbone Global Opportunities fund. He believes the problem is that investors are not secure enough about the levels of growth elsewhere to move into less familiar areas. He says that a confirmed earnings recession may, counterintuitively, be the stimulus investors need to look elsewhere, as long as inflation (and therefore interest rates) are relatively benign: “The recession fear will open the door to rate cuts and the start of a new cycle.”
If this confidence were to materialise, the beneficiaries aren’t obvious. Capital may move to parts of the market showing similar growth, but overlooked by investors because they are outside the US. Edmund Harriss, chief investment officer at Guinness Global Investors, says: “The Taiwanese technology sector, which focuses on manufacturing, continues to benefit from the demand for extra computing power demanded by cloud computing and AI.
“It appears that the personal computer cycle is turning and sales are expected to grow 4% next year after two years of declines. After an earnings decline of 27% in 2023, following a bumper year in 2022, earnings for 2024 and 2025 are forecast to grow over 20% in each of those two years.” It may be a similar picture for companies such as ASML in Europe, which is a crucial part of the semiconductor supply chain, but doesn’t receive the same attention as an Nvidia.
Admans suggests investors might look for areas that are cheap, that are cyclical, or inflation-proof. ‘Cheap’ would be areas such as the UK. He adds: “Several factors could drive interest in these stocks: their appealing low valuations, the attention they are getting from foreign buyers, and the growing appeal of value stocks, particularly resource companies among large caps.” Cyclical stocks such as consumer discretionary, industrials and materials could be beneficiaries of structurally higher inflation, as could infrastructure sectors such as utilities.
The problem for the time being is that technology is not exciting, but neither is it obviously weakening. There is no compelling reason to look elsewhere. Were some confidence to return to markets, it seems likely that investors would start to examine the merits of other parts of the market more closely. However, the environment may have to get worse before we get there.