The technology sector has looked wobbly over the past week. High valuations leave it vulnerable.
- The technology sector has weakened in response to ballooning spending on AI
- The recent results still show strong growth for many companies in the sector
- High embedded expectations are problematic for the sector
The technology sector is looking like an increasingly precarious place to invest. The mega caps have been derailed by recent results showing ballooning spending levels on AI, while software companies have seen their share prices slump in response to Anthropic’s Claude Cowork tool. Chipmakers have also struggled, with AMD down over 17% in a single day. Has the reckoning for the inflated technology sector finally arrived?
The catalyst for the recent wave of selling has been the results from some of the major companies. Microsoft was the first to fall, after it reported a 66% year-on-year surge in its data centre spending, taking its capital expenditure to $37.5bn in the three months to December. Alphabet managed to avoid the worst of the falls, but Meta has seen its share price drop almost 10% over the past week alone.
A second wave of selling was prompted by results from chipmaker AMD. Revenues and first-quarter sales guidance were both ahead of expectations, but investors were concerned that data centre-related sales to China accounted for a larger share of its revenue than expected. Nevertheless, the share price decline looked out of all proportion to the magnitude of the problem.
None of the recent results for the sector are truly problematic. Microsoft’s earnings per share were still up 24% . AMD beat earnings expectations by $600m . The problem is the future. AMD had a forward price-to-earnings ratio of 38x – that’s higher than Nvidia’s 23x. Its valuation assumed that it would encounter no problems in the year ahead and execute perfectly on its growth ambitions. Its results suggested that may not be the case.
The technology giants are suffering from a familiar problem. If everyone has bought, there is only one way for a stock to go. Expectations may not have been at Dot-com boom levels, but they were high, and this left companies vulnerable to the slightest hint that they might not deliver as expected.
The opposite may be true for the software sector. The market appears to be assuming that AI will be all-conquering, destroying the business model for software providers in its wake. This assumption has also hit some of the UK’s data-focused businesses – Relx, Experian or the London Stock Exchange.
AI is still an unknown quantity. It may deliver fabulous productivity gains and transform businesses. It may destroy the software sector as we know it. However, until that is clear, the technology sector may be vulnerable to these hair-trigger moves. Investors will need to be cautious.
