Technology stocks continue to lead stock market gains in 2023.
The Information Technology and Communication Services sectors of the S&P 500 have gained more than 50% year-to-date through mid-November.
Investors are often drawn to the promise of technology stocks, but it’s important to be aware of their associated risks.
Technology-oriented stocks continue to make gains in 2023 following last year’s bear market. As the economy maintains modest growth and inflation slows, investors appear drawn again to the technology sector, as they were in the years leading up to 2022. A number of prominent technology stocks have generated above-average returns this year while much of the stock market has remained flat.
The technology sector and the resulting innovations that often have a visible impact on society typically attract significant investor attention. “Fast is getting faster, and speed, scale and efficiencies across the board don’t happen without technology,” notes Terry Sandven, chief equity strategist at U.S. Bank Wealth Management. “To a large degree, technology is impacting all sectors of the economy in all walks of life.”
Information technology stocks currently represent more than one-quarter of the benchmark S&P 500 Index, by far the largest sector. When you add in communications services stocks, many of which connect with the technology arena, the group represents more than one-third of the S&P 500.2 This means that individuals who invest in a broad stock market index already likely have significant exposure to technology stocks.
A group of “mega-cap” stocks have captured the attention of investors this year. These technology-oriented stocks, sometimes referred to as the “Magnificent Seven,” are among the largest in the S&P 500 index. These include Alphabet (Google’s parent company), Amazon, Apple, Meta Platforms (Facebook’s parent), Microsoft, Nvidia and Tesla. The seven stocks are responsible for a good portion of the S&P 500’s strong performance this year. Notably, Amazon and Tesla, while perceived to be technology companies, are actually classified as Consumer Discretionary firms in the S&P 500 index.
Yet the “Magnificent Seven” stocks only scratch the surface. Technology stocks represent a broad range of companies that cut across a variety of sectors within the broader stock market. New technologies and companies continually emerge. “Today much of the opportunity appears to be tied to artificial intelligence (AI), machine-learning commerce, cloud computing, data analytics and data security services,” says Sandven.
“Technology companies generally benefit from the fact that their growth is secular, tied to their innovation and adoption by consumers and businesses,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management.
Nvidia, a 30-year-old company that is heavily involved in the artificial intelligence arena, is a prime example of how the surge of excitement over the potential of AI can fuel investor enthusiasm. Through November 21, 2023, Nvidia stock rose an astounding 249% year-to-date.1
“AI offers the potential to lead to much more innovation and greater efficiencies,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. Yet Haworth cautions that some perspective is helpful. “This appears to represent more of a technological evolution, rather than a revolution.” Haworth notes that a surge in technology stock prices that was fueled in part by AI enthusiasm earlier in 2023 may level off, though remain an important theme for the sector going forward.
Beyond AI, Sandven also cites medical advancements as another area contributing to technological breakthroughs. “For example, wearable devices that track exercise patterns and provide other readings may provide key information to help medical professionals deliver specific advice to benefit your health.”
For more than a decade (through 2021), stable economic growth, low inflation and low interest rates proved to be a fertile environment for many growth stocks, including technology issues. Investors bid up prices of some stocks to very high multiples (a stock’s price-to-earnings ratio), far in excess of historic averages for the broader stock market, anticipating significant earnings growth far into the future.
However, the environment changed once the Federal Reserve implemented a significant shift in its monetary policy, including a rapid hike in the federal funds rate, from near 0% in early 2022 to 5.50% (upper end of fed funds target rate) by July 2023.
“Investors were willing to pay a premium for the potential future growth of technology stocks under more favorable inflation and interest rate circumstances,” says Haworth. “The environment is far different today, so investors should expect that it will be hard for certain technology stocks to replicate those results.”
The change in the underlying economic environment took a toll on technology stocks in 2022. The Communication Services and Information Technology Sector of the S&P 500 declined more than 31%, lagging what was already a down year for the broader S&P 500 (down 18%).3
However, the sector rebounded dramatically in 2023, gaining 51.8% through November 21, easily outpacing what was already considered a solid quarter of performance for the broader S&P 500 index (up 20.0%).3
Haworth notes that some technology appear better positioned than others. “To this point in 2023, markets rewarded secular growth names that appear able to grow faster than the economy as a whole.” Haworth also believes that some of the largest technology companies are in a solid position to weather the storm of higher interest rates. “Because of their healthy balance sheets, a number of these firms can self-fund growth and don’t need to issue bonds and deal with higher borrowing costs. In effect, the financial impact of higher interest rates on many of these companies is negligible.” Yet the calculation of future earnings potential now must be weighed against elevated interest rates, which could also create headwinds for some tech firms.
Does 2023’s tech stock rally raise concerns that selected technology stocks may become overvalued? “These stocks can be described as not particularly cheap and not particularly expensive, but generally reflective of underlying expected growth rates for these companies,” says Haworth. “Technology companies generally benefit from the fact that their growth is secular, tied to their innovation and adoption by consumers and businesses. These firms aren’t as reliant on the economic cycle to generate growth as are companies in other industries.”
“It’s too early to say that happy days are here again,” says Sandven, “but over the long term, technology stocks can be expected to remain highly visible in the broader market.” Sandven believes that technology advancements will continue, which presents new investment opportunities.
Haworth agrees that technology stocks have a bright future. “Innovations will continue to change the world and that will create investment potential,” says Haworth. But he recommends investors take a selective approach. While some technology startups achieve tremendous success, many firms fail to get off the ground. In addition, factors such as increased regulation regarding AI and social media is a potential concern on the horizon that could affect business prospects. Investors should be certain to weigh these factors as they consider the role of technology stocks in their portfolios.
Mutual funds and exchange-traded funds (ETF) that track a major index like the S&P 500 provide significant exposure to this prominent segment of the broader market.
As you assess the most effective ways to position your portfolio consistent with your goals and time horizon, be sure to consult with your financial professional.
The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. It is an unmanaged index and direct investment in the index is not possible.
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