The outlook for US tech stocks following the sector’s outperformance year-to-date

The strong YTD rally in all things tech, especially the “magnificent 7” US stocks have led many market participants to question whether the 40% gain in Nasdaq between Jan-July1 is sustainable or not, and whether this is the start of a new bull market.
Key takeaways from previous bull markets
Through studying bull markets over the past 40 years, here are a few takeaways: every decade, investors get swept up in a theme that spawns a significant re-rating of that asset group.
In the early 1980s, it was energy stocks (which made up 1/3rd of the S&P 500); in the late 1980s it was Japan (which made up 45% of the MSCI world index2 and six of the ten largest companies in the world were Japanese banks); in the 1990s markets were captivated by the internet, and in the early 2000s it was China.
By 2021, investors poured money into tech, particularly software companies and US mega-cap tech. In 2022, tech stocks experienced a bear market as market participants pivoted towards cyclical stocks such as materials, energy and industrials.
But two interesting developments occurred earlier this year that has driven tech back into favour: 1) China’s reopening has disappointed and 2) a breakthrough in generative AI – the advent of ChatGPT.
I believe the two developments explain for the narrow rally in tech stocks. Though since early August, it appears as though the tech rally has fizzled, notwithstanding the recent rally in the world’s largest GPU manufacturer due to an analyst’s bullish comments.
Still, there are a confluence of reasons to suggest that the tech rally might be over as investors chase greener pastures: from the recent rise in energy prices, more Chinese stimulus to come to the loosening monetary policy environment in EM.
Even the UST 10-year yield appears very attractive on a risk/reward basis, having recently breached 4.2%.3 Needless to say, there are plenty competing investment opportunities.
![Nasdaq Composite Index [rebase 12/31/2019=100]](/content/dam/invesco/apac-master/en/image/insights/2023/marco/august/the-outlook-for-us-tech-stocks-following-the-sectors-outperformance-year-to-date/chart-nasdaq-composite-index.jpg)
Source: Macrobond. Data as of 18 August 2023.
Outlook
Now, in order for Nasdaq to hit a new high, I believe one of the three needs to happen:
- Earnings growth needs to meaningfully improve – likely though not guaranteed due to higher borrowing and labour costs;
- Lower interest rates – possible, Fed Funds futures points to Fed cuts starting next year;
- Improved risk premium – unlikely since VIX volatility index already near an all-time low and the US primary election season starts in a few months which is bound to rankle markets.
I believe as of this point, US growth stocks at current valuations could face some stiff, though certainly surmountable headwinds for the rest of the year.
References:
-
1
Source: Bloomberg, NDX 1st January – 31st July 2023
-
2
Source: MSCI Developed Markets Indexes – MSCI
-
3
Source: Bloomberg, 21 August 2023