Investment Institute
Technology

US cements itself as the global centre of tech innovation

  • 29 May 2024 (5 min read)
KEY POINTS
The US tech sector continues to outperform expectations, driven in part by advances in artificial intelligence
There are a wealth of innovative tech companies in other areas such as cloud computing, electronic design and cybersecurity
Given the ongoing global digital transformation, we believe the US tech sector will continue to offer considerable potential investment opportunities

The US technology sector’s vigour is showing no signs of abating given 2023’s superior performance has firmly spilled into 2024. Last year the Nasdaq delivered a total return of 45%1  and 2024 quickly witnessed the tech-heavy index hit new highs bolstered by excitement around the tech sector, while the wider S&P 500 also reached a fresh peak.2

These exceptional returns illustrate the industry’s superior growth rate, strength of earnings and expectations of the potential of generative artificial intelligence (AI).

The so-called ‘magnificent seven’ - Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – all of which have big stakes in the AI game, have garnered much of the attention as their respective share prices soared last year. In 2023 the S&P 500 delivered a 26% total return and the seven firms accounted for the majority of this.3

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High earnings, high valuations

US technology stock valuations have naturally risen on the back of the sector’s success. The price-to-earnings (P/E) ratio – a measure of a firm’s share price relative to its earnings per share - of the S&P 500 Information Technology (IT) sector is at 27.7, against 19.4 five years ago. 4

But while valuations are richer, relative to recent history - and relative to the wider S&P 500 average - they reflect expectations of higher earnings growth, driven by developments in AI and the sector’s ability to beat earnings forecasts.

The sector’s latest set of earnings reports continue to highlight this. Alphabet – Google’s parent company – reported a better-than-expected 15% increase in first quarter (Q1) revenue to $80.5bn and announced its first dividend.5

Elsewhere Microsoft beat expectations with a 17% increase in total revenue to $61.9bn in the first three months of 2024 as chief executive Satya Nadella hailed “a new era of AI transformation”.6

Cloud computing helped to deliver better-than-expected Q1 earnings for Amazon7  while Facebook owner Meta also beat forecasts, with a 27% rise in Q1 revenue.8

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Future driver

While AI has been with us for some time – such as Amazon’s Alexa or Apple’s Siri – the arrival of generative AI, which can produce and create images, text and videos, as well as a myriad of other kinds of content, has been viewed as a seismic game changer. 

History has shown us that technological advances have boosted productivity, reducing the need for labour in certain sectors, but simultaneously created jobs, often in new areas e.g. the shift from agriculture to manufacturing.

Generative AI’s economic impact could be as far-reaching as previous mass tech breakthroughs and it has the potential to boost productivity and growth - a truly exciting possibility that suggests material change both socially and economically.

Consultancy McKinsey & Company estimates that generative AI has the potential to add up to $4.4trn annually in economic value to the global economy as the technology could further automate activities that presently take up most of workers’ time.9 In our view, from an investment perspective the possibilities are considerable.

Tellingly, 179 S&P 500 companies mentioned the term “AI” during their Q4 2023 earnings conference calls - the second-highest number since 2014 – while the highest was in Q2 2023, according to FactSet.10

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Entrepreneurial ambition

There are a multitude of reasons to be upbeat on the US tech sector. For example, US industrial policy is helping accelerate technological innovation there as legislative milestones such as the Infrastructure Investment and Jobs Act – known as the Bipartisan Infrastructure Law - and Inflation Reduction Act (IRA) highlight the government’s ambitions in terms of fortifying its domestic technology capabilities.

Additionally, the US’s innate entrepreneurial spirit makes it uniquely positioned to drive and benefit from the technology race. Following the bursting of the technology bubble at the turn of the century, many investors were left nursing some significant losses, but US investors were unbowed and still sought out new opportunities.

Several of the tech companies that survived the period are among today’s giants, including Amazon, Microsoft and Apple. Even going into and during the global financial crisis many big US tech companies continued to make acquisitions, taking a longer-term view that digitalisation was an ever- increasing structural trend.


Beyond the magnificent seven

But beyond the US tech behemoths, there is a wealth of innovative companies, and while they may not rise to the same scale as the giants, they boast very strong business models setting them up for potentially significant future growth.

California-based ServiceNow, for instance, has a cloud computing platform which helps firms manage digital workflows. Essentially it is a software-as-a-service (SaaS) operation which focuses on inward-facing parts of an organisation, helping companies manage IT service requests and human resources processes. Some 85% of the Fortune 500 work with the firm which has seen its shares rise by more than 50% over the past year.11

Electronic systems design specialist Cadence - another California native - provides software which enables users to design and simulate how a semiconductor or a system works, before it goes into the costly production stage. The firm has seen its shares jump 38% over the past 12 months.12

Unsurprisingly in today’s digital economy, cybersecurity is a key growth area – especially as the damage caused by digital breaches is expected to hit $10.5trn annually by 2025 – a 300% increase from 2015 levels.13  It’s a market forecast to grow to $425bn by 2030 – up from $154bn in 2022.14

Again, the US is home to numerous market leaders in the space including Palo Alto Networks which provides services ranging from vulnerability assessments to managed security services and even damage control consulting. The sector’s potential and the company’s foothold in the space has taken its shares up by 55% over the past year. Other US leaders in the sector include cloud security company Zscaler and Texas-based Crowdstrike. 

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Future prospects

Given the level of digital transformation that multiple US – and global - industries are going through and AI’s long-term potential, the outlook for the US tech sector looks very positive. Even so, it’s unlikely to match its recent run without enduring a correction, and not all the US giants have had a smooth run so far in 2024, but it may be a case of taking advantage of the dips for investors intending to build positions. Of course, there is much uncertainty still clouding markets – including over how AI is regulated, monetary policy, global geopolitical tensions and of course the outcome of November’s US presidential election.

But fundamentally, we believe the US technology sector – especially the possibilities presented by AI’s advancement - will continue to offer considerable potential investment opportunities. It will be the centre point for technological innovation for years to come.

References to companies are for illustrative purposes only and should not be viewed as investment recommendations.

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