Artificial intelligence exuberance is masking broad weakness in the tech sector, investors say

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Enthusiasm for artificial intelligence is masking weakness in much of the technology sector, with many companies “still in a recession” after a slowdown that began in 2022, according to investors and analysis of recent financial reports.

Massive share price gains for big companies predicted to be early beneficiaries of artificial intelligence, such as Nvidia and Microsoft, helped erase memories of a terrible 2022, when the tech-dominated Nasdaq Composite fell by nearly Trinity.

Yet beneath the surface, many non-AI-focused tech companies have struggled to regain momentum.

“When you look at technology outside of AI, there’s not that much going on,” said Tony Kim, head of technology investing in BlackRock’s fundamental equities division. “Many (sub)sectors are still in recession. The only thing that really grew was AI.”

More traditional technology areas such as software, IT consulting and the production of electronic equipment for other sectors such as manufacturing and the automotive industry have faced difficulties, including weak demand and a hangover from overexpansion and overstocking stocks during the coronavirus pandemic. Some have also suffered directly from the rise of AI, as customers with limited budgets redirect investment.

Dustin Moskovitz, the Facebook co-founder who is now Asana’s chief executive, summed up the situation for many companies last week as the business software group cut its forecasts for the rest of the year.

“What we’re seeing in tech is another kind of unwinding of the over-hiring and over-spending that we saw at the start of the pandemic,” he told analysts. “And then all of that is coupled with what I think is massive uncertainty in the economic environment. And then also just with how AI is going to evolve.”

Recent financial reports show that most large technology companies have grown more slowly than in the past, while many smaller companies are actively shrinking.

Groups in the S&P 500 IT sub-index grew revenue by an average of 6.9 percent over the past 12 months, according to Bloomberg data, compared with a five-year average of 10 percent. About three-quarters of companies grew more slowly than their recent average.

Earnings per share rose an average of 16% over the past 12 months, down from 21% over the past five years.

The weakness is more evident in small-cap indices, where there is no push from megacap groups. In the Russell 2000, technology was the second-worst performing sector in terms of earnings growth in the second quarter, according to data from LSEG. Revenue fell 6.1 percent from a year earlier, while profits fell 2.8 percent.

“Generative AI is masking a cyclical downturn in many other core sectors,” said Ted Mortonson, technology strategist at RW Baird. “Everyone is hoping things will improve over the next few quarters, although hope is not an investment strategy.”

Even within subsectors that have been caught up in the AI ​​excitement, such as semiconductors, some business lines have struggled. Brice Hill, chief financial officer at chip equipment supplier Applied Materials, told analysts last month that “we’re seeing particularly strong traction around AI and data center computing,” but there were “points of weakness in the end markets.” automotive and industrial”. “.

“Everywhere you look industrially, it’s similar,” said John Barr, a portfolio manager at Needham Funds, which has invested in several semiconductor companies, including Applied Materials. “Current growth is not that high, so what we’re looking for are companies that have a stable business and are investing in something new.”

Investor exuberance around AI-focused companies has faded since the start of the summer, leading many commentators to predict a prolonged shift in investor focus from Big Tech stocks to sectors such as financial services and industrials.

Some tech insiders are hoping for a similar rotation within the industry from the biggest AI stocks to more unloved corners of the industry. While few companies are forecasting the kind of triple-digit growth that Nvidia has reported in recent quarters, there are signs that some of the worst-performing parts of the tech sector are turning a corner.

“I think we’re seeing a stabilization – things have stopped getting worse in those more sensitive areas on a macro level, and if rates come down, that will help,” said Tony Wang, portfolio manager for the science and technology fund of T Rowe Price.

“I feel like the idea that AI is the only thing that works has been the case for the last couple of years. I’m not sure that will be the case for the next two.”