Thought of the day

The top US tech firms lagged the broader market in September, with fears that interest rates will stay higher for longer outweighing hopes that the sector will be boosted by fast-growing demand for artificial intelligence. The FANG+ index, which tracks the 10 most traded US tech stocks, fell 6% in September, versus a 4.9% decline for the S&P 500 index. The tech sector is typically more vulnerable than the market overall to a rise in interest rates, which lowers the discounted present value of more remote profits. So, the 50-basis-point rise in the yield on the 10-year US Treasury in September was a headwind for the sector. The Nasdaq 100 index, a broader measure of the tech sector, is now down 6.3% versus its recent peak at the end of July.

But we have recently become more positive on the industry, raising the global and US technology equity sectors to neutral from least preferred in our global strategy. Pressures from higher yields should abate as economic growth slows, and inflation continues to moderate in the US. Our base case is that the yield on the 10-year US Treasury will fall from 4.66% at present, the highest level since 2007, to 3.5% in 12 months. While that should provide broad support to the tech sector, we advise investors to focus on specific areas of opportunity.

The upside to the tech sector from artificial intelligence is likely to broaden, in our view. Anticipation about the artificial intelligence revolution has already driven significant gains for some individual stocks this year. AI-chip manufacturer Nvidia is already set to become the eighth most profitable company in the United States. However, as applications for AI expand, we expect more stocks within the sector to benefit. Notably, we think software and internet stocks are well positioned to ride the next wave as companies try to monetize their investment in AI. We also expect companies that deliver enabling technologies and those that deliver storage, transmission, protection, and analysis of digital data to benefit from the rise of AI.

Government efforts to accelerate the transition to green energy is driving innovation. We see the most potential for growth in 1) wind and solar photovoltaic (PV) energy and associated battery storage; 2) battery-powered electric vehicles; and 3) low-carbon energy technologies used in buildings. We recommend a diversified approach across the global greentech theme, with the greatest opportunities across enabling technologies, like renewable energy, transport, batteries, hydrogen, digitalization, and energy efficiency, and in longer-term investments like our “Clean air and carbon reduction” theme.

Education services provided by companies and institutions—often driven by technology—look set for strong growth. This is thanks to a wide variety of drivers, including the growing middle class in emerging markets, accelerating urbanization, and faster changing professional environment. Spending worldwide on education has been increasing. In particular, education technology (edtech) is a global phenomenon offering greater personalization, engagement, flexibility, efficiency, and productivity. The introduction of generative AI initially posed headwinds for education services companies, but as edtech companies integrate AI into their own offerings, we believe these concerns will begin to dissipate for the companies leading the way on adopting AI.

So, we suggest investors consider adding exposure to disruptive technologies and those with the highest growth potential. We see most potential in the highest margin tech industries like software, internet, and semis. We prefer exposure to large-caps, since we believe the big will get bigger in the AI era.