Investing in Tech Stocks | U.S. Bank (2024)

Technology stocks, drivers of equity market performance in 2023 and much of 2024, underperformed other parts of the market in July and August. During that time, the S&P 500’s information technology sector declined nearly 2% in value, in contrast to a 2.6% gain for the broader S&P 500.¹

“We’re seeing a rotation now into stocks that benefit from lower interest rates,” says Rob Haworth senior investment strategy director at U.S. Bank Wealth Management. “Real estate, utilities, defensive stocks and smaller company stocks are currently capitalizing on expectations of declining interest rates.” This has, at least temporarily, made technology stocks less attractive.

Growing interest in artificial intelligence (AI) applications appears to be the key factor underlying the tech sector’s growth. Companies that provide the backbone of AI infrastructure, such as the semiconductor chip maker Nvidia, have been the biggest beneficiaries of corporate AI spending. Nvidia stock grew from $14.61/share at the end of 2022 to approximately $118/share by August 2024.²

Haworth says AI and cloud computing account for a significant portion of today’s corporate spending, as companies seek to enhance productivity and boost their bottom lines. “Equity markets are paying close attention to this trend, and companies that provide AI and cloud computing solutions are generating significant profits.”

Tech stocks remain popular

Investors have long been drawn to the market’s tech sector and the resulting innovations that often have a visible impact on society and capture the public’s imagination. “Fast is getting faster, and speed, scale and efficiencies across the board don’t happen without technology,” notes Terry Sandven, chief equity strategist at U.S. Bank Wealth Management. “To a large degree, technology is impacting all sectors of the economy in all walks of life.”

Information technology stocks currently represent the largest sector of the benchmark S&P 500 Index, comprising more than 31% of the index’s value. When you add in communications services stocks, many of which connect with the technology arena, the group represents close to 40% of the S&P 500.³ This means that individuals who invest in a broad stock market index likely already have significant exposure to technology stocks.

“It’s important as a signal for the economy overall that we see market leadership broaden beyond technology names,” notes Haworth. “However, it doesn’t mean that investors are ready to lower expectations for AI companies, which would primarily benefit the technology sector.”

After enjoying an extended period of outsized performance relative to the broader S&P 500, investors may wonder whether tech stocks remain attractive. How will conditions in the underlying economy affect the environment for these stocks?

An evolving tech sector

Technology stocks are prominent among what are considered the “mega-cap” stocks of the S&P 500. six of the top seven stocks in the index (Microsoft, Nvidia, Apple, Alphabet (2 classes), Meta Platforms) are in the information technology and communication services sectors. Those six listings alone represent more than one-fourth of the market capitalization of the S&P 500.⁴

But these prominent stocks only scratch the surface. Technology stocks represent a wide range of companies that cut across a variety of sectors within the broader stock market. New technologies and companies continually emerge. Yet in today’s market, corporate AI spending is the biggest tech stock booster.

“Investors have been excited by AI and for the most part, have put money to work in companies that play a part in producing AI capabilities,” says Haworth. “What’s not clear yet is how companies investing in AI as a way to increase efficiencies or monetize services for end users will benefit from these advancements. Eventually, we will likely see AI spending plateau, because we can probably only build so much.”

Haworth says productivity growth is a key measure to watch in determining the effectiveness of AI implementation. Productivity measures the level of inputs required, including labor, to generate a certain amount of output. “In general, U.S. productivity trended lower after World War II, but since the onset of COVID-19 in 2020, we’ve seen some productivity improvement,” says Haworth. “If AI helps boost productivity, that will support not only corporate earnings and current rising stock valuations, but individual prosperity as well.”

Will tech stocks continue gaining?

Over four of the previous five years, technology stocks have outpaced the broader stock market. 2022 was a notable exception. So far in 2024, technology stocks are again outperforming the broader S&P 500. Tech stocks enjoyed a solid bump in May and June, but in July, the market began to broaden out to the benefit of other sectors. The communication services and information technology sectors retreated modestly in July and August, but still exhibit an edge over the broader market.¹

“The key question is whether current lofty valuations for some tech stocks can be sustained by real revenue growth,” says Haworth. He notes that if technology stocks again lead the market in 2024, it may signal greater challenges for non-technology firms. “These tech companies need the firms that serve as their customers to also be in a strong financial position to invest in more technology,” says Haworth. He notes that technology companies continue to be among the most profitable based on 2024 earnings reports.

Although the technology sector is always subject to short-term volatility, Sandven remains optimistic about the sector’s long-term potential. “If you look at what backs up this move in AI-associated stocks, it is continued corporate capital spending,” he says. “Companies are looking to get bigger, faster and stronger. They’re not doing that through hiring more people. They’re doing that through technology spending.”

Haworth also believes that some of the largest technology companies are in a solid position to cope with higher interest rates. “Because of their healthy balance sheets, a number of these firms can self-fund growth and don’t need to issue bonds and deal with higher borrowing costs. They also hold large cash reserves, which can be safely invested and earn high interest rates.”

At current high valuation levels, are there inherent risks with technology stocks? “It’s fair to say that tech stock valuations are elevated, but I don’t think they can be described as extreme,” says Haworth. To this point, valuations aren’t outpacing revenue and earnings growth, but if that starts to happen, expect markets to get more cautious about technology stock prospects.”

The future of technology stocks

“Over the long term, technology stocks can be expected to remain highly visible in the broader market,” says Sandven. He believes that technology advancements will continue, which presents new opportunities for investors.

Haworth agrees that technology stocks have a bright future. “Innovations will continue to change the world and that will create investment potential,” says Haworth. Importantly, however, he notes that investors need to be selective in their approach to this sector of the market. While some technology startups achieve tremendous success, many firms fail to get off the ground. In addition, factors such as increased regulation regarding AI and social media and potential antitrust action against the largest technology companies represent potential concerns that could affect business prospects. Investors should be certain to weigh these factors as they consider technology stocks’ role in their portfolios.

As you assess the most effective ways to position your portfolio consistent with your goals and time horizon, be sure to consult with your financial professional.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. It is an unmanaged index and direct investment in the index is not possible.

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