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The enthusiasm for artificial intelligence masks weakness across much of the tech sector, with many companies “still in recession” after a slowdown that began in 2022, according to investors and analysis of recent financial reports.
Massive gains in the share prices of major companies that were supposed to be the primary beneficiaries of AIStocks like Nvidia and Microsoft have helped erase memories of a terrible 2022, when the tech-dominated Nasdaq Composite fell by nearly a third.
However, beneath the surface, many tech companies that aren’t focused on AI are struggling to regain momentum.
“Outside of AI, tech is not very hot,” said Tony Kim, head of technology investments in BlackRock’s fundamental equities division. “A lot of subsectors are still in recession. The only thing that’s really growing is AI.”
More traditional technology sectors, such as software, IT consulting and the production of electronic equipment for other sectors such as manufacturing and automotive, have faced challenges, including weak demand and the consequences of overexpansion and overstocking of inventories during the coronavirus pandemic. Some have also suffered directly from the growth of AI, as customers with limited budgets shift their investments.
Dustin Moskovitz, Facebook co-founder and now CEO of Asana, summed up the situation for many companies last week as the enterprise software company cut its forecast for the rest of the year.
“What we’re seeing in the tech sector is still kind of the tail end of the hiring and the spending binges that we saw at the beginning of the pandemic,” he told analysts. “And all of that is on top of what I think is considerable uncertainty in the economic environment. And then, also, how AI is going to evolve.”
Recent financial reports show that the majority of large tech companies are growing more slowly than in the past, while many smaller companies are actively slowing down.
Groups in the S&P 500 IT subindex grew revenue an average of 6.9% over the past 12 months, compared with a five-year average of 10%, according to Bloomberg data. About three-quarters of the companies grew at a slower pace than their recent average.
Earnings per share have grown an average of 16% over the past 12 months, compared with 21% over the past five years.
The weakness is more evident in small-cap indices, where megacaps aren’t driving the earnings gains. In the Russell 2000, the technology sector was the second-worst performer in terms of revenue growth in the second quarter, according to LSEG data. Revenue fell 6.1% year over year, while profits declined 2.8%.
“Generative AI is masking a cyclical slowdown in many other key sectors,” said Ted Mortonson, technology strategist at RW Baird. “Everyone is hoping things will improve in the coming quarters, although hope is not an investment strategy.”
Even within sub-sectors that have been swept up in the AI hype, such as semiconductors, some industries have struggled. Brice Hill, chief financial officer of chip equipment supplier Applied Materials, told analysts last month that “we’re seeing particularly strong traction in AI and data center computing,” but that there were “pockets of weakness in the automotive and industrial end markets.”
“Everywhere you look on the industrial side, it’s the same,” said John Barr, a portfolio manager at Needham Funds, which has invested in several semiconductor companies, including Applied Materials. “The growth right now is not very strong, so we’re looking for companies that have a stable business and are investing in something new.”
Investor enthusiasm for AI-driven companies has waned since early summer, leading many commentators to predict a prolonged rotation of investor attention away from Big Tech stocks and toward sectors such as financial services and industrials.
Some tech insiders are hoping for a similar intra-sector rotation from the biggest AI stocks to less-favored parts of the industry. While few companies are predicting the kind of triple-digit growth that Nvidia reported In recent quarters, there have been signs that some of the worst performing sectors of the technology sector are turning the corner.
“I think we’re seeing a stabilization – things have stopped getting worse in the most macro-sensitive areas, and if rates come down, that will help,” said Tony Wang, portfolio manager of T. Rowe Price’s science and technology fund.
“I feel like the idea that AI is the only thing that works has been valid for two years. I’m not sure it will be valid for the next two years.”