Are Technology Stocks Still a Good Place to Be?

Technology stocks were among the worst performers in 2022 but led the U.S. equity market rally during the first half of 2023, accounting for more than 78%¹ of the entire equity market’s gain—in large part because of the excitement around artificial intelligence (AI) as well as the effectiveness of internal cost cuts. Is the latest revival just a short-term surge, or is a new growth phase ahead for technology-related industries? While we never recommend “chasing performance” or listening to the “noise” of big headlines, here’s why we believe in the technology sector aside from AI and with a longer-term perspective.

Integral to Entire Equity Market. Technology companies comprise more than 28% of the total S&P 500^® Index as of June 30, 2023.² Equally important, technology is a growth sector driving innovation and productivity gains throughout all sectors and industries—transforming health care, industrials, financials, real estate, automotive, retail, media, transportation, defense, energy, construction, agriculture and more at unprecedented speeds.

Driven by Secular Trends. Secular drivers of change are not going away, making technology increasingly ubiquitous. Virtually every company in every industry is looking to use technology to get closer to its customers, innovate more quickly and operate more efficiently. An exponential proliferation of data and digitization amid an evolving financial landscape, advances in medical treatment, revolution in manufacturing, and structural shifts in where we work and the way we consume goods and services is providing long-term upside potential for technology companies capitalizing on data storage, security, analysis, infrastructure, digital transformation transitions and more.

Targeted Growth Sub-Sectors. Within the technology sector, there is great opportunity for investment diversification. While some sub-sectors, such as personal computers, may be mature, others, such as semiconductors, automation & robotics, advanced driver-assistance systems, cloud computing, Internet media & services, data centers, software, electronic components, 5G wireless, financial technology and cybersecurity are still areas considered to have long runways of growth ahead. As just one example, worldwide end user spending on public cloud services is projected to rise 21.7% to $597.3 billion in 2023.³ AI will surely be a powerful theme, too, but it’s only one of many, and it’s still in its infancy.

Supported by Fiscal Policy. In 2022, the Creating Helpful Incentives to Produce Semiconductors and Science Act (CHIPS Act) was signed into law, creating the largest publicly-funded research and development (R&D) program in U.S. history. Providing unprecedented support for the technology sector, the CHIPS Act appropriated approximately $280 billion to bolster U.S. semiconductor capacity, catalyze R&D, and create regional high-tech hubs and a bigger, more inclusive STEM workforce.

Wide Capitalization Investment Choices. The mega-cap technology companies that drove the U.S. equity market rally during the first half of 2023 have high quality and defensive attributes, including strong free cash flow, high barriers to entry and high visibility revenue models—especially attractive given an uncertain economic outlook. But looking beyond the technology titans for unsung innovators can be rewarding, too. Small-cap, niche-focused technology companies can often support higher valuations over time, with better execution, an ability to fend off competition and appeal as a quality acquisition candidate.

Attractive Fundamentals. Technology company fundamentals remain robust, supporting the longer-term growth prospects of the sector. Despite a recently escalating interest rate environment, technology companies overall tend to have higher profit margins and lower debt to service ratios compared to companies in other sectors. Instead of debt, much of these companies’ financing has been through the issuance of equity and/or larger cash balances. Further, the technology sector boasted the highest returns on equity of any sector in the U.S. equity market, as measured by the S&P 500^® Index, through the first half of 2023.⁴

Additionally, the fourth quarter of 2022 saw hiring freezes and layoffs sweep through the technology sector. However, many technology companies have weathered the economic slowdown and flourished in 2023 by cutting costs, increasing efficiencies and renewing focus on the bottom line, thereby growing revenue and earnings. Indeed, about 75% of technology companies reporting first quarter 2023 earnings and sales results in the spring of 2023 exceeded market expectations, well above historical averages for the sector.⁵

Specialized Products/Services. Technology companies thrive on innovation, typically offering  niche, or specialized, products or services. Notably, in 2022, merger and acquisition activity surged in the enterprise information technology field.⁶ Overall, technology, media and telecommunications deals accounted for 30% of all global deal values in 2022.⁷ In the U.S. alone, technology sector deal activity slowed but remained strong in the first half of 2023 with 577 deals made valued at $39.4 billion compared with 1,681 deals made valued at $362.5 billion in 2022.⁸ Key factors driving activity included the opportunity to leverage new technologies already developed by others and the need to sustain innovation, expedite advances and replace lost revenue from maturing products. 

Reduced Inflation Impact. For several reasons, technology stocks are generally well-positioned to perform well in the decelerating but still-sticky inflationary environment that exists. First, technology-enabled innovation helps offset the impacts of inflation for companies in a wide variety of industries. Second, innovative technology companies typically have pricing power. And third, inflation often encourages businesses to invest in technology to reduce costs and improve efficiencies.