AI Excitement Hides Big Weakness in Tech Sector, Investors Say

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The enthusiasm for artificial intelligence masks weakness in most tech sectors, with many companies “still in recession mode” following a downturn that is expected to begin in 2022, according to investors and analysts who analyzed recent earnings reports.

Strong stock price gains for large companies are expected to be early beneficiaries Artificial Intelligencesuch as Nvidia and Microsoft, have helped erase memories of a horrifying 2022, when the tech-dominated Nasdaq Composite index fell by nearly a third.

Beneath the surface, however, many tech companies that aren’t focused on AI have struggled to regain momentum.

“When you look at technology outside of AI, there’s not a lot going on,” said Tony Kim, chief investment officer of technology at BlackRock’s fundamental equities division. “A lot of [sub]-Industries are still in recession. The only thing that is really growing is AI.”

More traditional technology sectors such as software, IT consulting and electronics manufacturing for other sectors such as manufacturing and the automotive industry have faced challenges, including weak demand and backlogs due to over-expansion and excess inventory during the coronavirus pandemic. Some have also been directly affected by the growth of AI, as budget-constrained customers have shifted their investments.

Dustin Moskovitz, the Facebook co-founder who is now the CEO of Asana, summed up the situation for many companies last week as the business software giant scaled back its forecast for the rest of the year.

“What we’re seeing in tech is still the unwinding of the over-hiring and over-spending that we saw at the beginning of the pandemic,” he told analysts. “And then all of that combined with what I think is a lot of uncertainty in the economic environment. And then also just with how AI is going to play out.”

Recent financial reports show that most large tech companies are growing more slowly than they used to, while many smaller companies are actively downsizing.

Groups in the S&P 500 IT subindex have grown revenue by an average of 6.9 percent over the past 12 months, compared with a five-year average of 10 percent, according to Bloomberg data. About three-quarters of companies are growing at a slower pace than their recent average.

Earnings per share have increased by an average of 16 percent over the past 12 months, down from 21 percent over the past five years.

The weakness was more pronounced in small-cap indexes, which lacked a boost from large-cap groups. Technology was the second-worst performing sector in the Russell 2000 in terms of revenue growth in the second quarter, according to data from LSEG. Revenue fell 6.1 percent from a year earlier, while earnings fell 2.8 percent.

“AI is masking a cyclical downturn in many other core sectors,” said Ted Mortonson, a technology strategist at RW Baird. “Everyone is hoping things will get better in the next few quarters, although hope is not an investment strategy.”

Even in sectors that have been caught up in the AI ​​hype, like semiconductors, some businesses are still struggling. Brice Hill, chief financial officer at chip equipment supplier Applied Materials, told analysts last month that “we are seeing particularly strong traction around AI and data center computing,” but there is “some weakness in the automotive and industrial markets.”

“Everything you look at on the industrial side is the same,” said John Barr, a portfolio manager at Needham Funds who has invested in a number of semiconductor companies including Applied Materials. “There’s not a lot of growth right now, so we’re looking for companies that have a stable business and are investing in something new.”

Investor excitement around AI-focused companies has waned since early summer, leading many commentators to predict a prolonged shift in investor attention away from Big Tech stocks and toward sectors like financial services and industrials.

Some tech experts are hoping for a similar rotation in the industry from the biggest AI stocks to less-favored corners of the sector, while some firms are predicting triple-digit growth. Nvidia In recent quarters, there are signs that some of the worst-performing parts of the tech industry are turning around.

“I think we’re seeing some stabilization — things have stopped getting worse in the more macro-sensitive areas and if interest rates come down that will help,” said Tony Wang, portfolio manager at T Rowe Price’s science and technology fund.

“I feel like the idea that AI is the only thing that works has been true for the last two years. I’m not sure it’s going to be true for the next two years.”