The love-hate relationship with tech continues

Key takeaways

• The tech love-hate relationship continues. A once-in-a-generation technological advancement offers significant potential, but the wide range of outcomes and the difficulty identifying long-term winners and losers amplify each narrative and data point.
• Sharp setbacks have been a recurring feature of this bull market. Tech has still gained 238% since October 2022 versus 114% for the S&P 500, despite five double-digit pullbacks along the way.
• The narrow leadership that worried investors has temporarily become narrow weakness. Technology (tech) and communication services were the only sectors up in September and are the only two down in October, while participation has broadened elsewhere. Earlier this month, tech was the only sector to join the S&P 500 at an all-time high before the recent setback.
• Valuations have compressed while earnings remain strong. Tech trades at 19.9x forward earnings, near the lows of this bull market, while its premium to the broader market has narrowed to just 6%.
• Bottom line: The pullback may have further to run, but the weight of the evidence suggests the longer-term tech uptrend still deserves the benefit of the doubt. Accordingly, we maintain our long-standing overweight to the tech sector and positive view of the growth style.

What happened

After only recently reaching a new all-time high earlier this month, the tech sector fell more than 6% last week. The downturn was led by semiconductors, which are now down more than 15% over the past 10 days alone.

The weakness reflects renewed scrutiny around the scale of capital spending, the path to profitability and AI monetization, and concerns that higher interest rates will make it more difficult to fund investment through debt.

Our take

The market continues to swing between optimism and pessimism regarding tech’s outlook. That is understandable. A once-in-a-generation shift creates significant potential, but the range of outcomes is wide and identifying the long-term winners and losers is difficult. The internet era offers an important reminder: a technological transformation can reshape the economy while producing sharply different outcomes across companies and investors.

Sharp pullbacks are part of the pattern

Pullbacks have been a feature of tech’s strong run. Since this bull market began in October 2022:

• The tech sector has experienced 12 five-day declines of more than 6% and five double-digit pullbacks ranging from 10% to 26%.
• Semiconductors have experienced five 10-day declines of more than 15%.

Despite these setbacks, the Philadelphia Semiconductor index has gained more than 400% during this bull market, while the tech sector has gained 238%, more than double the S&P 500’s 114% return. The recent weakness should be viewed in the context of these outsized gains.

Zooming out further, history is inconclusive: similar price action for the tech sector has occurred during both routine corrections and major downturns. Several prior pullbacks during this bull market also went further before finding their footing. The magnitude of the decline alone is not enough to declare that the correction is complete or that the longer-term trend has changed.

From narrow leadership to a narrow weakness

One of the more constructive developments is what has occurred outside the headline indexes. In September, tech and comm. services were the only S&P 500 sectors to advance. In October, they are the only two sectors in the red.

The narrow leadership that worried investors earlier in the month has temporarily become narrow weakness. This reversal suggests capital is rotating toward areas that had lagged rather than exiting the market altogether. Rotation does not eliminate risk, but it is healthier than broad liquidation.

The pullback in rates has supported this rotation, allowing economically sensitive and defensive areas that had lagged sharply to rebound. 

Valuations have reset, earnings have not

The fundamental evidence remains more constructive than the recent price action suggests. Notably, recent weakness has been driven primarily by valuation compression and investor concerns, not a visible deterioration in consensus earnings.

• Tech now trades at 19.9x forward earnings, below the 21.9x level when ChatGPT launched and slightly below the 20.1x level reached early on during the oil shock in March of this year.
• The sector’s premium to the broader market has narrowed to just 6%, at the low end of the past decade.
•  At the same time, over the past three months, tech’s forward earnings estimates have risen approximately 17%, almost double the increase for the S&P 500 and trailing only the energy sector.

To be fair, prices historically tend to lead fundamentals, making major shifts difficult to identify in real time. Still, the reset in prices and valuations suggests the market is already discounting significant uncertainty.

Bottom line

The tech love-hate relationship continues, and that will likely remain a defining feature of this cycle. Every spending announcement, financing development, earnings report, and demand signal is being amplified because the range of potential outcomes from the AI buildout remains unusually wide.

The pullback may not be over. Still, valuations have compressed, earnings momentum remains strong, and demand for AI and related infrastructure remains robust.

We’ll continue to keep an open mind, but for now, the weight of the evidence suggests the tech bull market still deserves the benefit of the doubt. Accordingly, we maintain our long-standing overweight to the tech sector and positive view of the growth style.

As always, we will continue to follow the weight of the evidence, keep an open mind, and update our views as conditions evolve.