Tech Stocks Poised to Lead Beyond the ‘Magnificent 7’
Last year, many stock investors were concerned about the performance of tech companies with disruptive impacts on the technology sector. They feared that higher interest rates and a weak macroeconomic backdrop would continue to cause underperformance. However, this uncertainty created a unique entry point for investors into the innovative tech ecosystem, particularly in software and semiconductors.
In 2023, generative artificial intelligence (AI) took center stage in the U.S. equity market, driving wealth creation and market sentiment. The Magnificent Seven tech stocks, including Apple, Microsoft, Alphabet, Amazon.com, Nvidia, Meta Platforms, and Tesla, experienced significant share-price gains and accounted for 70% of the Nasdaq Composite Index’s performance. These stocks justified their price return with earnings per share growth of at least 50%.
Smaller tech stocks, on the other hand, did not fare as well. Over the past two years, the MSCI ACWI Global Small Cap Tech index has declined by 5% due to a weaker spending environment and pressure on multiples from higher rates. The global information technology (IT) spending growth has been below its long-term averages, further contributing to the underperformance of the tech sector.
Multiples for smaller tech stocks were also under pressure as the 10-year U.S. Treasury bond rate increased from 1.6% at the start of 2022 to 3.9% at the end of 2023. However, the growth rate for worldwide IT spending is expected to more than double in 2024. As the Federal Reserve’s rate-hiking cycle nears its end, pressure on multiples should decrease.
Given this backdrop, market leadership is likely to shift. Investors should pay close attention to stocks beyond the Magnificent Seven. Valuations in the software sector, in particular, are attractive, with a narrow spread between the fastest- and slowest-growing companies. This presents great opportunities for investors to enter the market at reasonable prices.
Pipelines are building for multiple companies across various industries and applications, including next-generation data storage, cybersecurity, and software-development tools. With the improving spending environment and easing rate backdrop, more companies are expected to benefit from the accelerating innovation and develop fresh solutions, products, and applications that could drive growth.
Investors seeking exposure to AI opportunities should focus on three key areas:
1. Enablers of AI: Cloud providers and semiconductor manufacturers and capital equipment companies will benefit from the increasing demand and investment in AI data centers and the buildout of cloud vendors.
2. Data and Security: Software companies specializing in data management and security for AI models stored in the cloud are expected to experience a surge in demand as companies digitize their infrastructure and leverage AI.
3. Applications: Software and other enterprises across various sectors that leverage AI broadly will see a reacceleration in demand as AI products and services become more specialized and domain-specific.
Opportunities to invest in companies that could lead the tech sector change are plentiful. Some of the tech stocks in Goldman Sachs Asset Management portfolios that could benefit from the growth trends in 2024 include AMD, Micron Technology, MercadoLibre, and HubSpot. Goldman Sachs Asset Management currently holds positions in these stocks.
With the acceleration and disruptive nature of the tech industry, it is important for investors to consider dedicated allocations to tech for potential wealth creation opportunities. As the industry evolves and new solutions emerge, tech stocks have the potential to deliver significant returns.
Sources:
– Goldman Sachs Asset Management
– MarketWatch
