Volatility could rise again until investors are convinced that the US economy is not heading into recession. Given the risks surrounding the US election and geopolitical tensions, future gains could be slower. However, we believe that the recovery in technology stocks still has room to run and see tailwinds from both a fundamental and technical perspective.
There is still potential for growth in AI spending. Strong investment in artificial intelligence has fueled the tech rally this year, and big tech companies are on track to increase their capital spending by 43% year-on-year in 2024. However, contrary to popular perception, capital spending intensity—capex divided by revenue—for big tech companies remains below its historical highs. Our analysis shows that big tech companies’ capital spending could potentially increase by as much as 25% in 2025—much more than consensus forecasts of 10-15%. This strong capital spending outlook is particularly positive for AI enablers in the semiconductor space.
Recent earnings reports indicate strong demand for AI and increasing usage. Taiwan Semiconductor Manufacturing Company (TSMC) recently reported 45% year-over-year revenue growth for July, an acceleration from year-over-year growth of 33% in June. Separately, a Taiwanese chip testing and packaging company increased its planned 2024 capital spending by 57% due to rising AI demand, while another company that assembles AI servers for major technology companies issued a strong second-half outlook in addition to a record second-quarter profit. Walmart management talked about how the use of generative AI has led to productivity gains in its recent earnings call. Without focusing on individual names, we believe these examples show that AI demand remains strong amid increasing adoption and monetization.
Investors’ positioning should be supportive. The recent correction in technology stocks was partly due to the unwinding of yen carry trades, in which investors borrow the Japanese currency at near-zero interest and invest in higher-yielding markets, including global technology stocks. But those positions have largely been liquidated. Data from the U.S. Commodity Futures Trading Commission shows leveraged funds’ yen positions have shrunk to the smallest net short position since February 2023. Other data showed both hedge funds and retail investors are getting back into the market, while corporate buybacks are expected to pick up soon as earnings season ends.
With earnings growth expected to grow by 15-20% for the technology sector over the next six quarters, we see a compelling risk-reward outlook for the global technology sector. We believe AI will continue to drive growth in the years to come, and investors should ensure they are adequately invested in the beneficiaries of the semiconductor and software industries. Those concerned about increased volatility can use structured strategies for a more defensive position.
Key Contributors: Solita Marcelli, Mark Haefele, Sundeep Gantori, Kevin Dennean, Daisy Tseng, Jon Gordon, Christopher Swann
Original report: The tech rally could continue, August 19, 2024.
