Big Tech Reclaims Dominance

What's fueling the rally in mega-cap tech stocks?

Key Takeaways

  • After a down 2022, big tech stocks have surged this year.
  • First-quarter earnings at some of the biggest names were better than expected, prompting cautious optimism that the companies are moving beyond their 2022 challenges.
  • Deep cost reductions and a stabilizing digital ad market may have brightened the outlook for tech companies.
  • Innovation in cloud computing and prospects for artificial intelligence have invigorated the long-term outlook for tech investors.

For mega-cap tech stock investors, 2022 was a period they'd sooner like to forget. This year's strong start may be helping. Big tech's rally in 2023 thus far has not only fueled the broader market, but also prompted debate over whether the industry's recent challenges are in the past.

The titans of tech have been responsible for much of the S&P 500's gains this year. Several factors have supported the resurgence. After earnings fell in 2022, first-quarter results at many large-cap tech companies were better than expected. In addition, decelerating inflation may signal that interest rates are in the process of peaking, reducing macroeconomic headwinds, according to Denise Chisholm, director of quantitative market strategy at Fidelity Investments.

"Technology could actually be in the sweet spot," Chisholm says. "There is a sense that the big deceleration that happened last year has bottomed out."

Big tech's trajectory

The segment's challenges last year followed what was more or less a decade of market dominance. Over the 2010s, investors flooded into tech as profits surged and near-zero interest rates helped buoy price-earnings ratios (P/Es). The onset of the pandemic then accelerated the digitalization of daily life. Hybrid work and a greater reliance on technology helped propel tech stocks to new highs, and companies in the sector embarked on hiring sprees to support the rapid expansion.

But in 2022, as the global economy turned rocky and the Fed began raising rates, many big tech companies were still hiring as though growth would continue at the pandemic-era pace, according to Matthew Drukker, a research analyst at Fidelity Investments, who manages the Fidelity® Select Communication Services Portfolio (FBMPX). At some companies, this resulted in costs growing at a faster rate than revenues, he says, which slowed over 2022 as economic uncertainty prompted some businesses to reduce spending on digital advertising.

At the same time, the stocks began to lose favor with investors. Market uncertainty and rising interest rates in 2022 led investors to prefer more defensive stocks. Historically, P/Es in the technology sector have been negatively impacted by rising rates. Higher borrowing costs can hinder the present value of future profits and adversely affect spending on research and development, a key component of innovation at many tech firms.

The combination of flagging business results and waning investor support made for a challenging year for the segment and declines in big tech names in 2022 contributed to drag the S&P 500 lower. Given that the index is weighted by market value, large-cap tech stocks hold an outsized influence.

Resurgence in 2023

By late 2022, share prices at some companies and expectations for future profits may have gotten overly pessimistic, Drukker says, potentially setting the companies up to beat forecasts. Many big tech names started putting plans into place to help turn around business results, including broad cost-cutting measures, deep headcount reductions, and a renewed focus on the bottom line. And as 2023 progresses, the digital advertising market has begun to stabilize.

First-quarter earnings at many of the most-prominent companies may have reflected those improvements.

tech taking off chart

The market is starting to feel more comfortable that the period of weakest revenues may be behind us," Drukker says.

What next for "big tech"?

It's important to note that the term "big tech" is often used to describe an expansive range of businesses covering computer hardware, consumer electronics, semiconductors, media, communications, and software. So why are they sometimes grouped together? Over the past decade, the dominance of large hyper-growth companies gave rise to the FAANG acronym, an umbrella term for Facebook (now Meta), Apple, Amazon, Netflix, and Google (now Alphabet). Yet within the 11 sectors on the S&P 500, they are categorized in communication services or information technology.

market caps

Looking ahead, a lot depends on macroeconomic conditions, the health of the consumer, and overall demand for advertising. But continued innovations—such as developments in cloud computing and artificial intelligence—mean the future may still be bright for this group, even as companies are maturing.

Up in the cloud

Over the past decade, cloud computing has been a key growth driver for the dominant players, Microsoft (MSFT), Amazon> (AMZN), and Alphabet> (GOOG). With most organizations increasingly migrating IT infrastructure to the cloud, these segments have generally been a boon for profitability.

As of the first quarter of 2023, Amazon's AWS commanded the largest market share with 32%. Microsoft's Azure held 23%, followed by Google Cloud at 10%.

cloud market share

As innovation in the space advances, propelled by burgeoning technologies such as generative AI which can create data, text, images, and code, global spending on cloud services is forecast to grow 21.7% to $597.3 billion in 2023, according to Gartner, a research and consulting firm.

"If you take a longer-term view, there's a case to be made that there's still a lot of growth left in terms of demand for cloud computing," Drukker says. "It's still pretty much a healthy 3-player market that can power free cash flow and revenue for these companies."

Artificial intelligence

Technology companies have been investing in artificial intelligence for several years. But the launch of OpenAI's ChatGPT in November 2022 signaled a quantum leap ahead for the technology and its potential applications.

If 2022 was a year that brought big tech back down to earth, AI could be the development that has it aiming for the stars again. Throughout Silicon Valley, the race is on to bring AI applications to market, ranging from chat bots, image generators, AI-powered web search, and tools for developers.

"One theme that's emerged that's been a positive in terms of opportunity for these companies is how they're going to harness generative AI," Drukker says. "A lot of tech is driven by innovation that can deliver value for consumers and for their ad partners."

Many of tech's biggest names are now positioning AI as central to future growth, directing resources and capital toward new projects, or interlacing it with existing products and services. This was evident on first-quarter earnings conference calls, where talk of AI dominated much of some companies' forward-looking commentary.

Looking ahead at tech

A return to tech's hyper-growth days of the 2010s may be unlikely, given that many of these companies are maturing and may have saturated some of their respective markets. Regulatory scrutiny over AI and government concerns over the size and influence of many big tech companies could also affect growth prospects and valuations.

But following 2022's downtrend, the outlook for big tech appears to be brightening. Cost efficiencies, a potential pause in Fed tightening, and excitement over innovations in cloud computing and AI may help support the sector going forward.


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