What happened?

US stocks rallied on Thursday after strong results from AI chipmaker Nvidia added to confidence over the outlook for the tech sector. The S&P500 rallied 2.1% to close at a record high, with Nvidia itself up 16.4%. That added roughly USD 230 billion to the company’s market capitalization, breaking a record set only earlier this month by Meta Platforms for the largest one-session increase in value in history. The earnings announcement included an above-expectations 265% increase in quarterly revenues compared to a year earlier. Chief executive Jensen Huang said AI had “hit the tipping point,” with demand “surging worldwide across companies, industries, and nations,” as he forecast sales for the coming quarter ahead of analysts’ projections.

The latest rise left the S&P 500 index up 6.9% year-to-date, with gains led by large-cap US tech and growth stocks. The FANG+ index, which tracks the top 10 most traded tech stocks in the US, is up 15.1% so far this year, building on last year’s 96% advance.

The rally has come despite investors continuing to revise down the likely speed of rate cuts by the Federal Reserve, amid strong economic data. The minutes of the Fed’s most recent policy meeting released earlier this week confirmed that officials are in no rush to reduce rates, with Richmond Fed President Tom Barkin also expressing fears this week that services inflation could remain elevated. Markets are now implying around 80 basis points of rate reductions this year, down from a peak of 170 basis points in January. The yield on the 10-year US Treasury rose by 1 basis point on Thursday, to 4.33%, up from around 3.88% at the start of 2024.

The latest data on the US economy remained robust: US manufacturing activity increased this month at the most rapid pace since September 2022, according to survey data from S&P Global, and data also showed sales of previously owned US homes rose by the most in close to a year in January.

What do we think?

The speed of the tech rally has left investors wondering whether to take profits. While we see merit in rebalancing portfolios, we believe that retaining strategic exposure to US large-cap technology is important, and the rise in tech stocks could go further still.

We think generative AI will prove to be the growth theme of the decade, and Nvidia’s earnings report demonstrates the current strength of AI infrastructure spending. We estimate that AI industry revenues are set to expand by around 70% a year until 2027, with AI monetization improving swiftly amid new AI applications in copilots, cloud, models, and other software. Even these estimates could prove to be conservative given the rapid pace of development, including this week’s launch of OpenAI’s text-to-video model.

The technology sector’s forward price-to-earnings ratio of 27 times is close to a 22% premium versus its 10-year historical average. But it has fallen from a peak of around 34 times in April 2021, and earnings growth is rapid. We expect an 18% rise in earnings per share for global tech in 2024.

How do we invest?

Amid the surge in technology stocks and uncertainty about the Fed path, we favor strategies that:

Optimize tech exposure: Future investor performance will rest heavily on exposure to the technology sector, in our view. We believe investors cannot afford to be underinvested—we expect rapid earnings growth and think that the big will get bigger. Equally, investors need to be wary of overconcentration and overexposure, and diversify across a broader array of companies and disruptive trends if necessary.

Capture upside and protect downside: A mix of low equity market volatility and high bond yields makes this an attractive time to consider strategies that can allow investors to capture market upside while protecting against downside. These can be particularly effective ways to invest in markets that may have downside risks but also high potential upside, including technology.

Anticipate a “Goldilocks” scenario: Beyond technology, we think investors should also prepare for a potential broadening of the equity market rally, which could materialize with a combination of Fed interest rate cuts, still-robust growth, and falling inflation. We would expect US and European small-caps, select Swiss mid-caps, and emerging market equities to be particular beneficiaries in this scenario, given their interest rate sensitivity and low valuations.

Manage liquidity: While markets had become too upbeat about the speed of Fed easing in late 2023 and at the start of 2024, we still expect interest rates to fall in 2024. This means that cash will progressively deliver lower returns, creating a risk for investors who do not lock in returns today. Investors should diversify a liquidity strategy beyond cash and money market funds, with a combination of fixed term deposits, bond ladders, and structured investment strategies to cover expected portfolio withdrawals over the next five years.

For more on the “Four things no great portfolio can do without,” please refer to our latest House View Monthly Letter.