The tech sector benefits from a range of tailwinds and artificial intelligence (AI) now stands out as one of the most important. Indeed, in Q1 earnings calls, tech companies have so far referenced AI twice as much as the previous quarter, suggesting an increased focus. As AI employment scales up across all sectors, we believe it could become an important long-term driver for technology in particular.
While there are many themes to technology’s long-term growth story, there are three that stand out to us right now: artificial intelligence (AI), cybersecurity and cloud computing. In the last few months, AI has commanded much attention on its own, and it is also a driver in demand for cloud computing use and the need for more cybersecurity solutions.
AI has been mentioned twice as frequently in Q1 earnings calls so far compared with the previous quarter, according to Refinitv. Microsoft and Alphabet (the latter of which is in the communication services sector) led the chat.
However, despite the excitement, Microsoft, Alphabet and other leading stocks in AI are not breaking out sales or profitability yet. For now, investors are still learning about the potential capabilities and opportunities to be created.
The market for AI software, services and hardware is expected to double from last year’s level before 2026. Meanwhile, according to one report, the applications of big data and AI could double the gross value-added growth rates of developed markets by 2035 and add 0.8-1.4 percentage points to global productivity growth in the long run.1
Employment of AI should benefit all sectors through productivity growth, but technology stands to benefit the most, given its industry representation. The benefits include: the help of large language models, such as ChatGPT, to write code and develop software; increasing demand for semiconductors because of the significant computing power needed for training these models; more data centres required to store data; and the aforementioned use for cloud computing and the need for cybersecurity, with AI also helping to provide solutions.
Microsoft’s use of AI is best known with Bing. The search engine integrates AI features, which should improve customisation and search relevance, among other factors. Microsoft is well-placed to monetise AI models given its scope to bring AI use to market in the vast development, public cloud infrastructure and desktop application categories over time.
Apple does not feature as highly as an AI beneficiary, despite being an early AI adopter to power Siri. However, while the company does not have a large language model, we can expect announcements on AI applications, such as an AI-powered health coaching service and new technology for tracking emotions, in its latest attempt to lock in users with health and wellness features.
Meanwhile, the third largest sector constituent, Nvidia, is powering ahead as rapid advancement in AI is leading to a potential shortage of GPUs (graphic processor units), which are instrumental in viewing images on devices.
Recent news from the largest tech companies confirms why the sector remains a favourite with investors. From State Street custody data, we can see that even though institutional investors are more overweight than average over the last five years, they continue to add to their exposure. We also see from ETF flows that net new assets into this sector are higher than any other sector so far this year.
We selected technology in the Q2 SPDR Sector & Equity Compass as one of the three sectors best placed to thrive in an environment where rate expectations are peaking and economic growth forecasts are under pressure. The qualities of the major tech stocks, reflected in their high profitability and returns, should boost their resilience in a more difficult growth environment.
The majority of stocks in the sector have seen their share prices rise this year, but two – Apple and Microsoft – account for two-thirds of the sector’s return YTD. The next largest contributor is chip-maker Nvidia. Given the rise of these companies’ share prices and their significance to the sector, the current reporting season is important. Microsoft reported Q1 earnings last week, with Apple results expected on Thursday this week and Nvidia later in May.
1Bank of America AI Primer, 28 February 2023.
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