Nvidia chips on display during the Taipei Computex expo in Taipei, Taiwan, on May 29. Tech stocks are responding to the opportunities provided by the AI explosion. Photo: Bloomberg
Opinion
Macroscope
by Chris Iggo
Macroscope
by Chris Iggo
Why tech stocks are thriving on the global stage despite headwinds
In spite of enduring a period of falling earnings, forecasts of recession and rising geopolitical tensions, the technology sector is leading global returns
Drivers of performance include the US pursuing more tech investment, increased focus on supply chains and the explosion of interest in artificial intelligence
Technology stocks have led returns in global equity markets so far this year. At the MSCI World level, the information technology sector has delivered total returns of more than 25 per cent compared to about 10 per cent for the total index.
Global energy stocks – last year’s winners – have delivered a negative return this year. The world, it seems, has gone from dealing with a real income-destroying energy price shock to embracing growth enhancing technology again. This is good for Asia and good for medium-term economic growth.
The United States is leading the way, as is normal. In fact, most of the total return from the S&P 500 has come from just a handful of mega-cap technology stocks in 2023. There are concerns that this concentration of leadership means that investors who do not want increased exposure to technology stocks in their portfolios will underperform the market benchmark indices.
However, it is important to understand the drivers of this performance. While there is not the same level of concentration in other markets, technology is one of the best-performing sectors in the European equity market. South Korea and Taiwan – both technology-heavy markets in Asia – are two of the world’s best-performing markets.
Something is driving technology even when the sector has gone through a period with falling per-share earnings, forecasts of recession, and geopolitical tensions and regulatory threats that remain a constant source of risk to the sector.
US President Joe Biden delivers his remarks during a visit to Taiwan Semiconductor Manufacturing Company’s first fabrication plant in Phoenix, Arizona, on December 6, 2022. Photo: Reuters
Drivers of performance include the fiscal incentives associated with the US administration’s pursuit of higher investment in digitalisation and the energy transition, increased focus on the security of supply chains in response to Covid-19 and recent geopolitical developments, as well as the explosion of interest in and application of artificial intelligence.
Digitalisation and climate change solutions are linked, be it through the continued growth in the electric vehicle market or through the investment necessary to achieve the “smart” integration of multiple renewable energy inputs into electricity distribution systems. Given the trillions of dollars still to be spent in the energy transition globally, the scope for growth in different technologies related to electrification in transport, buildings and supply chain management is clear.
In the US, alongside the subsidies available for investment in energy transition technologies, the Biden administration is also keen to support the growth of domestic manufacturing of semiconductors and other high-level computer hardware.
The value chain for artificial intelligence also provides huge growth opportunities. Data collection and storage form the basis of the value chain and will support growth in computer processing and storage hardware. The next stage up the value chain is the machine learning process for large language models which form the intellectual core for artificial intelligence. The phenomenon of ChatGPT shows the potential for rapid growth of such models.
02:02
ChatGPT competes with Japanese prime minister for best responses to National Assembly questions
ChatGPT competes with Japanese prime minister for best responses to National Assembly questions
Then there are the applications at the enterprise level with companies not wanting to be left behind in utilising AI to boost their own growth. All of this requires vast amounts of spending on chips, hardware and cloud computing. The performance of stocks such as chip makers Nvidia and Taiwan Semiconductor Manufacturing Company this year are real-life examples of how technology shares are responding to the opportunities provided by the AI explosion.
The performance of technology also reflects a different macro environment to the one in place during 2022. Inflation has peaked, and we are close to the peak of US interest rates. Bond yields have fallen, and this has boosted the valuation of long-duration technology stocks.
On a broader equity market view, strong nominal GDP growth globally has lifted sales revenue and allowed companies to maintain strong profit margins through exploiting their pricing power in an inflationary environment. With long-term earnings growth potential superior to other sectors, it is not surprising that technology has done well.
Some caution is warranted. The Nasdaq 100 index has already delivered more than 25 per cent total return this year. A broader slowdown in economic growth and the impact of that on earnings cannot be ignored. Further declines in bond yields are not likely, so any further extension of valuation multiples in equities would make stocks look expensive compared to fixed income again.
However, China is recovering and there is a global surge in investment in technology across many sectors as countries seek to shore up the security of their supply chains. At the same time, changes to working patterns and labour shortages mean companies must keep investing in technology.
Returns on equity have been superior in the sector in the past. With the concentration of real and artificial intelligence in technology companies, this is likely to continue.
Chris Iggo is chair of AXA Investment Managers Investment Institute and chief investment officer of AXA IM Core
