The exuberance surrounding artificial intelligence (AI) has overshadowed broader weaknesses in the technology sector, according to investors and recent financial reports. While companies like Nvidia and Microsoft have thrived due to their early involvement in AI advancements, many businesses unrelated to the AI boom are still struggling to recover from the post-pandemic economic downturn. This contrast highlights a growing divide within the tech industry, where AI-driven companies are flourishing, while others face slower growth and even contraction.
Tony Kim, head of technology investing at BlackRock’s fundamental equities division, captured the sentiment by stating, “When you look at technology outside of AI, there’s not that much happening. Many [sub]-sectors are still in a recession. The only thing that has been really growing has been AI.” This reflects the broader struggle of tech companies that have not aligned their business models with AI innovations.
Much of the traditional tech sector, including software development, IT consulting, and electronic equipment manufacturing, continues to face weak demand. These industries are also suffering from the overexpansion and overstocking of inventories that took place during the COVID-19 pandemic. The growth of AI, in some cases, is exacerbating this problem, as companies redirect their budgets toward AI solutions, leaving little room for investment in other areas.
Dustin Moskovitz, co-founder of Facebook and now CEO of Asana, pointed to these challenges when discussing his company’s scaled-back forecasts for the year. “What we’re seeing in tech is still kind of the unwinding of the over-hiring and overspending that we saw at the beginning of the pandemic,” he told analysts. He further emphasized the uncertainty surrounding the economic environment and the unpredictable trajectory of AI development.
Financial reports from major tech companies reflect this subdued reality. While many firms continue to grow, their growth rates have slowed compared to previous years. According to Bloomberg data, groups in the S&P 500 IT sub-index increased revenues by an average of 6.9% over the past year, a noticeable drop from the five-year average of 10%. Around three-quarters of these companies are growing more slowly than their historical averages. Earnings per share have similarly declined, averaging 16% growth over the past 12 months, down from the five-year average of 21%.
Smaller companies have been hit even harder. In the Russell 2000 index, which represents small-cap stocks, technology was the second-worst-performing sector in the second quarter of 2023. Revenue in the sector fell by 6.1% year-on-year, and profits were down by 2.8%. This decline highlights the challenges faced by smaller tech firms that lack the financial resources and market influence of larger companies benefiting from the AI boom.
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“Generative AI is masking a cyclical downturn in a lot of other core sectors,” said Ted Mortonson, a tech strategist at RW Baird. He noted that while optimism remains high in AI-driven companies, it cannot hide the fact that many other tech businesses are facing tough conditions. Mortonson’s remarks underline the growing concern that AI enthusiasm is covering up underlying weaknesses in the broader tech industry.
Even within AI-related sectors, not all areas are thriving. For instance, Brice Hill, chief financial officer at Applied Materials, a leading chip equipment supplier, acknowledged that while AI and data center computing are driving demand, there are “pockets of weakness in the auto and industrial end-markets.” This sentiment was echoed by John Barr, portfolio manager at Needham Funds, who emphasized the importance of finding companies with stable business models that are investing in innovative solutions, despite current weak growth.
Investor excitement around AI-focused companies has tempered somewhat since early summer, leading many to predict a rotation of interest away from Big Tech towards more traditional sectors like financial services and industrials. Some industry experts also hope for an intra-tech shift, where investors move from mega-cap AI stocks to less celebrated areas of the tech world. However, few companies outside of AI are forecasting the triple-digit growth that Nvidia has experienced in recent quarters.
There are signs, however, that the tech sector may be stabilizing. Tony Wang, portfolio manager for T. Rowe Price’s science and technology fund, pointed to a potential turning point for some of the most battered segments of the industry. “I think we are seeing a stabilization — things have stopped getting worse in those more macro-sensitive areas, and if rates go down, then that will help,” Wang explained. Investors are cautiously optimistic that the tech sector could see broader recovery if macroeconomic conditions improve and interest rates decrease.
In conclusion, while AI’s rapid ascent has captured investor attention and driven significant gains for some companies, it has also masked deeper issues in the wider tech sector. Many non-AI tech companies are still grappling with the aftermath of the pandemic and a challenging economic environment. Investors and analysts will be watching closely to see if the rest of the tech industry can find its footing in the face of these challenges.
