Technology stocks have continued to outperform earnings coming in above expectations this year, yet cracks in investor confidence have begun to show in recent months following a period of market volatility.
The tech-heavy Nasdaq saw its worst single-day performance since 2022 in July, falling 3.6% on 24 July following lacklustre earnings from heavyweights Tesla and Alphabet. The index has recovered in the month since, but further questions are now being asked about whether overexuberance in the sector has dissipated.
The meteoric rise of tech stocks has been reflected in ETFs capturing the sector, but also broader exposures like the S&P 500. The Amundi MSCI Semiconductors ESG Screened UCITS ETF (CHIP) has risen 45.3% in 2024 and returned 144.6% between January 2023 and 27 August 2024.
Despite the Nasdaq’s dip in July, the index has delivered a 20.2% in the year to 28 August, outpacing the S&P 500's 18.6% gain.
Nvidia – the poster child of the early build-out of the AI theme – surged 239% in 2023 and continued its ascent with an additional 150% gain in the first half of 2024.
The boom of generative AI has driven tech's latest growth, with investor focus increasingly shifting toward companies involved in AI software and computer chip production.
Momentum has not stopped in recent months, with Q2 earnings growth for the tech sector standing at 20%, compared to 5% for non-tech sectors - surpassing expectations of 18% and 2% at the start of the earnings season, according to a report from BlackRock.
With Q2 earnings highlighting the sector's continued pace coupled with market jitters seen in July, the question remains whether prices keep rising or if investors will start pulling their cash.
Against this backdrop, ETF Stream spoke to fund selectors about whether tech stock prices can keep rising, if we are in a tech bubble and how best to use ETFs that capture tech within a portfolio.
Prices can keep rising, but costs present barrier
The decision to either withdraw funds from tech ETFs or continue investing hinges on whether investors believe tech stocks can sustain their growth.
Peter McLean, portfolio manager at Stonehage Fleming told ETF Stream he believes prices can keep rising on the basis that current valuations, although elevated, are justified by strong earnings.
This is seen with companies like Nvidia where the majority of stock price gains have been driven by underlying earnings rather than speculative valuation increases.
“If we take the case of Nvidia, around 97% of its share price growth of 2023 has come from underlying earnings as opposed to valuation,” he said.
Meanwhile, some investors may doubt that tech stock prices - especially AI stocks - can continue to rise due to the limited integration of generative AI into daily life, partly because of the high cost associated with it.
Stephen Kemper, chief investment strategist at BNP Paribas Wealth Management said the price of AI integration does not seem justified given how expensive it is, with cost being a significant barrier to the wider adoption of generative AI.
“Certain products are evolving and being developed, with AI starting to be integrated into some existing services. However, I have not seen much evidence yet that these AI services are truly justifying huge price increases,” he said.
The cost of generative AI is neatly outlined when comparing the cost of a ChatGPT search versus a Google search, with the former being up to seven times more expensive than the latter.
This could pose an even greater obstacle to the growth of generative AI, especially given the expectation that technological advancements in, for example, phones will continue, while prices remain stable.
“With high-end smartphones from Apple and Samsung – they have been priced around $1,000 for some time, but with each new model, you are paying the same amount for better features,” Kemper added. “The same pattern might apply to AI, we will see more advanced capabilities at similar price points.”
Dot-com bubble part two?
A concentration of the biggest names in tech might hark back to some features of the dot-com bubble, however, Alberto García Fuentes, head of asset allocation at ACCI Capital Investments, said we are not witnessing ‘part two’ of the dot-com bubble.
Tech companies today heavily contrast with the late 90s tech bubble, where companies invested heavily without profitability.
“These are very solid businesses”, McLean added. “Despite trading at high valuations, it seems justified and does not look like a bubble to us.”
Echoing his views, Kemper said: “That is probably where the comparison with the dot-com bubble stops making sense because nothing was profitable then. Today, [tech companies] are making a fortune of money.”
Fuentes pointed out that the cash flow of tech companies today also furthers their distinction from the tech companies of the dot-com bubble.
McLean concluded that people might be hasty to make comparisons to the dot-com bubble because when people see companies like Nvidia achieving massive share price gains -around 750% since early 2023 - they might instinctively draw comparisons.
“I think it is a case of people perhaps anchoring a little bit to prior examples rather than focusing on the fundamentals of the companies involved today.”
Capturing tech in a portfolio
McLean and Fuentes both blend different investment types within a global portfolio to ensure balanced exposure to technology.
For McLean, this is achieved through an S&P 500 ETF, given that about 30% of the S&P 500 is tech-focused.
“While we recognise the potential challenges facing the tech sector, we aim to create a diversified global portfolio by also investing in smaller and medium-sized companies, as well as more defensive sectors like healthcare,” he said. “This strategy helps mitigate risks while still capturing growth opportunities.”
Meanwhile, Fuentes said when tech company valuations are slightly “tighter” he will combine a tech ETF, such as the iShares S&P 500 Information Technology Sector UCITS ETF (IUIT) with an equal weight strategy to avoid overconcentration risks.
Conversely, Nathan Sweeney, CIO of multi-asset, said he has reduced exposure to US technology and instead increased exposure to areas of the market that will benefit from interest rate cuts.
“However, while investors are disappointed about technology stocks in the short term, we do remain positive over the longer term,” Sweeney added.
The final word
Overall, AI is a long-term theme and along the way there is likely to be periods of high sentiment towards the space.
McLean said the market is likely to be cyclical over time. “It seems we have moved past the initial phase of optimism and excess sentiment, and now we are entering a more volatile period.”
“The best strategy as an investor is to have an amount of allocation to the technology sector, but it truly well diversified and have other global themes and sectors that can create a very robust portfolio.”
This article first appeared in ETF Insider, ETF Stream's monthly ETF magazine for professional investors in Europe. To read the full edition, click here.
