Investing in Tech Stocks | U.S. Bank (2024)

In 2023, sectors headlined by major tech companies far outpaced the broader market, generating outsized gains in what was a solid year for the S&P 500 broadly. For example, the information technology sector of the index gained 57.8% for the year, compared to a return of 26.29% for the S&P 500 overall. The technology sector’s sizable 2023 returns helped offset notable setbacks for many of those same stocks in 2022, when a number suffered declines of 30% or more.¹

Investors have long been drawn to the market’s tech sector and the resulting innovations that often have a visible impact on society and capture the public’s imagination. “Fast is getting faster, and speed, scale and efficiencies across the board don’t happen without technology,” notes Terry Sandven, chief equity strategist at U.S. Bank Wealth Management. “To a large degree, technology is impacting all sectors of the economy in all walks of life.”

Information technology stocks currently represent the largest sector of the benchmark S&P 500 Index, comprising just under 29% of the index’s value. When you add in communications services stocks, many of which connect with the technology arena, the group represents more than 37% of the S&P 500.² This means that individuals who invest in a broad stock market index likely already have significant exposure to technology stocks.

Given their most recent price gains, do tech stocks remain an attractive value for investors? How will conditions in the underlying economy affect the environment for these stocks?

An ever-evolving tech sector

A group of “mega-cap” stocks recently attracted significant investor attention. These technology-oriented stocks, sometimes referred to as “the Magnificent Seven,” are among the largest in the S&P 500 index. These include Alphabet (Google’s parent company), Amazon, Apple, Meta Platforms (Facebook’s parent), Microsoft, Nvidia and Tesla. These seven stocks are responsible for 60% of the S&P 500’s strong performance for a 12-month period through January 22, 2024. They also represent 29% of the value of the market-capitalization weighted S&P 500.³ Notably, Amazon and Tesla, while perceived to be technology companies, are actually classified as Consumer Discretionary firms in the S&P 500.

These prominent stocks just scratch the surface. Technology stocks represent a broad range of companies that cut across a variety of sectors within the broader stock market. New technologies and companies continually emerge. “Today much of the opportunity appears to be tied to artificial intelligence (AI), machine-learning commerce, cloud computing, data analytics and data security services,” says Sandven.

Nvidia, a 30-year-old company that is heavily involved in the artificial intelligence arena, is a prime example of how the surge of excitement over the potential of AI can fuel investor enthusiasm. Over the course of 2023, Nvidia stock rose 239%.⁴

In recent months, significant attention has been given to advancements in generative AI, specifically applications such as ChatGPT. Generative AI systems are designed to develop original content by applying information the system “learns” from an existing data base. “AI offers the potential to lead to much more innovation and greater efficiencies,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. Haworth notes that most technology companies making significant AI investments are large, established firms that aren’t wholly reliant on success with AI to drive business results. “We don’t really see significant AI-only technology companies so far in today’s market,” says Haworth. “Successful AI launches can boost a company’s earnings, but not be the sole determining factor.”

How long can the tech stock surge persist?

For more than a decade (through 2021), stable economic growth, low inflation and low interest rates created a fertile environment for many growth stocks, including technology issues. Investors bid up prices of some stocks to very high multiples (a stock’s price-to-earnings ratio), far in excess of historic averages for some stocks. 2022’s bear market brought many technology valuations back down, but they again rose significantly in 2023.

“Fundamentals for technology stocks remain solid, particularly given the growing interest in AI applications and the desire of many corporate customers to use new technology to advance productivity,” says Haworth. “The key question is whether current lofty valuations for some tech stocks can be sustained by real revenue growth.” Haworth notes that if technology stocks again lead the market in 2024, it may signal greater challenges for non-technology firms. “These tech companies need the firms that serve as their customers to also be in a strong financial position to invest in more technology,” says Haworth. He notes that initial 4th quarter 2023 earnings reports send positive signals that some technology companies are generating the growth needed to justify their stock prices.

Over four of the past five years, technology stocks have outpaced the broader stock market. 2022 was a notable exception.

Haworth notes that some technology stocks stand out in today’s slow growth economy. “In 2023, markets rewarded secular growth names that appear able to grow faster than the economy as a whole.” Haworth also believes that some of the largest technology companies are in a solid position to weather the storm of a higher interest rate environment. “Because of their healthy balance sheets, a number of these firms can self-fund growth and don’t need to issue bonds and deal with higher borrowing costs. They also hold large cash reserves, which can be safely invested and earn high interest rates.”

At current high valuation levels, are there inherent risks with technology stocks? “At this point, the situation doesn’t look like a repeat of the ‘dot-com’ bubble of 1999-2000,” says Haworth. “During that time, stock prices soared for many young companies with interesting prospects, but no real earnings. That resulted in a significant price decline when the bubble burst.” Today, says Haworth, “Tech companies are generating earnings, but valuations of many tech stocks have been driven higher, so the question in 2024 is whether they can maintain earnings growth that lives up to current stock prices.”

The future for technology stocks

“Over the long term, technology stocks can be expected to remain highly visible in the broader market.” Sandven believes that technology advancements will continue, which presents new opportunities for investors.

Haworth agrees that technology stocks have a bright future. “Innovations will continue to change the world and that will create investment potential,” says Haworth. Importantly, however, he notes that investors need to be selective in their approach to this sector of the market. While some technology startups achieve tremendous success, many firms fail to get off the ground. In addition, factors such as increased regulation regarding AI and social media is a potential concern on the horizon that could affect business prospects. Investors should be certain to weigh these factors as they consider the role of technology stocks in their portfolios.

Mutual funds and exchange-traded funds (ETF) that track a major index like the S&P 500 provide significant exposure to this high-profile segment of the broader market. Technology is even more prominent in the NASDAQ Composite Index. It’s reasonable to expect that technology stocks will play a role in any broadly diversified portfolio.

As you assess the most effective ways to position your portfolio consistent with your goals and time horizon, be sure to consult with your financial professional.

The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general. It is an unmanaged index and direct investment in the index is not possible.

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