The S&P 500 Index, a benchmark indicator of large-cap stock performance, had record gains in May and June due to a rise in technology firms. Tech stock momentum stalled in mid-July, with key technology issues falling. The setback has not changed tech's lead in the S&P 500 this year, but its momentum looks to have stalled, at least briefly. Year-to-date until mid-July 2024, the information technology and communications services sectors have outperformed all other S&P 500 sectors, as they did in 2023. Investors' sustained enthusiasm for companies that are well-positioned to benefit from advances in artificial intelligence (AI) is driving sector gains.
This surge in technology stocks has not gone unnoticed by market analysts and economists. Many are drawing parallels to the dot-com boom of the late 1990s, but with a cautious optimism. Unlike the speculative fervor of that era, today's tech rally is largely backed by tangible advancements in AI, cloud computing, and data analytics. However, some experts warn that the concentration of market value in a handful of tech giants could pose risks to overall market stability.
"Investors have been excited by AI and, for the most part, have put money to work in companies that play a role in producing AI capabilities," says Rob Haworth, senior investment strategy director at US Bank Wealth Management. "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."
Investors have long been drawn to the market's technology sector and the resulting developments, which frequently have a visible impact on society and pique the public's interest. "Fast is getting faster, and speed, scale, and efficiencies across the board don't happen without technology," says Terry Sandven, chief equities strategist at US Bank Wealth Management. "To a large degree, technology is impacting all sectors of the economy in all walks of life."
The pervasive influence of technology across various industries has led to a blurring of traditional sector boundaries. Companies once categorized as retail, automotive, or healthcare are increasingly positioning themselves as tech firms. This shift is reflected in their business models, hiring practices, and capital allocation strategies. As a result, investors are faced with the challenge of accurately valuing these hybrid entities, which may not fit neatly into conventional valuation metrics.
"The key question is whether the current lofty valuations for some tech stocks can be sustained by real revenue growth," says Rob Haworth, senior investment strategy director at US Bank Wealth Management.
Information technology companies are currently the largest sector in the benchmark S&P 500 Index, accounting for more than 32% of the index's value. When you include communications services stocks, many of which are related to technology, the category accounts for more than 40% of the S&P 500. Individuals who invest in a broad stock market index are likely to have strong exposure to technology stocks.
This concentration of tech stocks in major indices has implications for passive investors and index fund managers. As these companies grow larger, they exert an increasingly disproportionate influence on index performance. This phenomenon has sparked debates about the need for alternative indexing methodologies that might provide a more balanced representation of the broader economy.
"It's important as a signal for the economy overall that we see market leadership broaden beyond technology names," Haworth says. "However, it doesn't mean that investors are ready to lower expectations for AI companies, which would primarily benefit the technology sector."
Do tech stocks still represent a good deal for investors, given their recent price gains? How will the underlying economy impact the environment for these stocks?
The answer to these questions may lie in the evolving landscape of global tech innovation. While U.S. tech giants have dominated headlines and market returns, emerging tech hubs in Asia and Europe are fostering their own ecosystems of innovative startups. This global diversification of tech talent and capital could reshape the competitive dynamics of the sector in the coming years, potentially offering new opportunities for discerning investors looking beyond the familiar names dominating today's indices.
An growing technology industry
The S&P 500's "mega-cap" stocks include technology stocks. Six of the top seven stocks in the index (Microsoft, Nvidia, Apple, Alphabet (2 classes), and Meta Platforms) are in the information and communication services industries. These six listings alone account for more than one-fourth of the S&P 500's market value.
However, these renowned stocks merely scrape the surface. Technology stocks represent a diverse group of corporations from many sectors of the stock market. New technology and businesses continue to emerge.
Nvidia, a 30-year-old firm with a strong presence in the artificial intelligence space, is a great example of how the wave of excitement about AI's potential may stimulate investor interest. Nvidia stock surged 239% in 2023 and is up another 138% year-to-date through July 19, 2024.
"Chip companies that are growing profits through strong order volume are, to this point, the biggest beneficiaries of the AI push," according to Haworth. "Nvidia's fast-rising stock values can seem unrealistic, but they are backing them up with very positive earnings results and favorable forecasts for future earnings." According to Haworth, AI and cloud computing represent for a substantial amount of today's corporate spending, as businesses attempt to increase efficiency and boost profits. "Equity Markets are paying close attention to this trend, and companies that provide AI and cloud computing solutions are generating significant profits."
According to Haworth, productivity growth is an important metric to consider when assessing the effectiveness of AI implementation. Productivity estimates the quantity of inputs, including labor, necessary to produce a specific 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," according to Haworth. "If AI helps boost productivity, that will support not only corporate earnings and current rising stock valuations, but individual prosperity as well."
How long can the tech stock rise last?
For four of the prior five years, technology stocks outperformed the overall stock market. 2022 was a remarkable exception. So far in 2024, technology stocks are again leading the market. Tech stocks rose significantly in May and June, but the market began to expand in July, benefiting other industries. Between July 10 and July 19, the Communication Services and Information Technology sectors fell more than 6% as investors shifted away from large-cap stocks and toward mid-caps. However, Communication Services and Information Technology have outperformed the S&P 500 year to date.
"The key question is whether current lofty valuations for some tech stocks can be sustained by real revenue growth," Haworth adds. He points out that if technology companies continue to drive the market in 2024, non-technology firms may face increasing hurdles. "These tech companies need the firms that serve as their customers to also be in a strong financial position to invest in more technology," Haworth points out. He observes that technology companies remain among the most profitable, according to first-quarter 2024 earnings reports.
Although the technology sector is prone to short-term volatility, Sandven remains confident about its long-term prospects. "If you look at what backs up this move in AI-associated stocks, it is continued corporate capital spending," adds the analyst. "Companies want to become bigger, faster, and stronger. They are not achieving this by recruiting more personnel. They're doing it with technology spending."
Haworth also feels that some of the top technological companies are well-positioned to weather the storm of rising interest rates. "Because of their strong balance sheets, many of these companies can self-fund growth and avoid issuing bonds and incurring higher borrowing costs. They also have substantial cash reserves that may be prudently invested and provide high interest rates."
Are there inherent risks with technology companies given their present high valuations? According to Haworth, "Tech companies are earning money, but the values of many tech equities have risen in response to earnings forecasts. The concern in 2024 is whether these companies can maintain profit growth that is commensurate with their current stock valuations."
Mutual funds and exchange-traded funds (ETFs) that track a large index, such as the S&P 500, provide significant exposure to this well-known area of the market. The NASDAQ Composite Index places an even greater emphasis on technology. Notably, technology stocks rank fourth in both the major mid-cap and small-cap stock indices.
The future of technology stocks.
"Over the long term, technology stocks can be expected to remain highly visible in the broader market," according to Sandven. He believes that technological developments will continue, creating new chances for investors.
Haworth feels that technology equities have a promising future. "Innovations will continue to change the world and that will create investment potential," Haworth explains. Importantly, he emphasizes that investors must exercise caution when approaching this market segment. While some technological startups are extremely successful, many others fail to get off the ground. Furthermore, growing regulation of AI and social media is a possible source of concern that may have an impact on business prospects. Investors should examine these variables when determining the position of technology stocks in their portfolios.
As the tech sector continues to evolve, environmental, social, and governance (ESG) considerations are becoming increasingly important for both companies and investors. Tech firms are under growing pressure to address issues such as data privacy, ethical AI development, and the environmental impact of their operations. Forward-thinking companies that proactively tackle these challenges may find themselves better positioned for long-term success, potentially offering a new dimension for investor analysis beyond traditional financial metrics.
Consult with your financial advisor as you consider the best methods to arrange your portfolio in accordance with your goals and time horizon.
The S&P 500 Index is made up of 500 commonly traded stocks that are thought to represent the performance of the US stock market in general. It is an unmanaged index, so direct investment is not feasible.
