Tech stocks have continued to perform well in 2024 relative to the broader market, but there has been wide divergence in returns, even among the ‘Magnificent 7’. Hyun Ho Sohn, portfolio manager of the £17bn Fidelity Funds Global Technology Fund, outlines why tech themes could broaden out beyond recent high profile winners and discusses some of the under appreciated opportunities he sees across the sector.
Overall, technology stocks have done well in 2024, both on an absolute basis and relative to the broader market. However, within the sector, there has been a wide divergence in performance. Large caps significantly outperformed small caps, and semiconductor stocks have delivered excellent returns. Software and internet stocks have also done well, while sub-sectors such as hardware, communications equipment, and IT services performed poorly. We saw divergence even within the ‘Magnificent 7’ mega caps, with some leading the rallies while other consumer names lagging.
The road ahead for AI
Investment in AI infrastructure remains strong, and almost every hyperscale company has increased its capital spending plans, benefitting semiconductor businesses. On the other hand, macro uncertainties are impacting some technology businesses. Although there are signs of stabilisation in hardware component and broad-based semiconductor businesses, the pace of recovery remains slow, and inventory levels in the communications equipment and electric vehicle value chain stay above average. With so many companies prioritising discretionary IT, projects keep getting pushed back, leading to weak results at many IT services companies and some software businesses.
Looking beyond the Magnificent 7, IT consulting, data infrastructure, and cloud computing are under-appreciated long-term beneficiaries of the AI era. Payment services and networks are also essential parts of the technology stack for e-commerce and omnichannel retail. Companies with the right scale and technology advantages will be able to capitalise on these long-term growth opportunities. On-demand media and music streaming are also still under-monetised, but industry leaders are well-positioned to benefit from further consolidation.
Many of the stocks viewed by the market as AI winners – like semiconductor and hardware companies – are priced at a premium. From a risk/reward perspective, this could make them less attractive to the discerning investor. The market expects a massive AI infrastructure buildout without any speed bumps, but despite generative AI’s long-term potential, there are also risks.
There are positive signs of generative AI adoption in digital media, creative industries, and consumer internet – where the uptake of new technology tends to be quick. For many large enterprises, however, particularly in regulated industries such as financial services, many generative-AI projects remain at the proof-of-concept stage.
Despite rapidly falling AI computing costs, there are many areas where those costs remain too high for mass adoption. For example, training large language models requires cutting-edge data centre infrastructure and consumes massive amounts of electricity, which could become a bottleneck. Given the cyclical nature of capital spending, if generative-AI adoption hits a speed bump, AI infrastructure demand will be hit even harder.
We are increasingly positive on small/mid-cap software companies, given the reviving appetite for M&A from both strategic acquirers and private equity firms. There have already been many confirmed deals and unconfirmed interest in areas such as data and design software, and we are finding more new ideas in this space.
2024 to see tech trends broadening
For the rest of 2024, we expect technology themes to broaden out, given the number of uncovered opportunities in the value chain. The reacceleration of the cloud will provide a tailwind for cloud infrastructure and software, while sub-sectors such as analogue semiconductors, IT services, and communications equipment are in the process of bottoming, and valuations are attractive. Given the elevated spending level and the slower-than-expected pace of generative-AI adoption at large enterprises, there are risks in some AI stocks.
The structural story of the tech industry still stands, but a discerning bottom-up stock-picking investment approach will be critical throughout the rest of the year. Following consensus and momentum carries a lot of risk and comes with a high premium that might not be worth paying. Even astute investors find it difficult to predict the future, so minimising risk when things go wrong is as essential for us as making money. Investing in companies with long-term earnings power, frequently in less-followed segments such as the small/mid-cap space, will help to minimise risk. There are many opportunities available in the tech sector for disciplined investors, the key is in picking companies with solid growth prospects combined with valuation discipline.
*Source: Fidelity International, 30 April 2024
