- Technology stocks have dominated the market for over a decade.
- But the strong performance of tech stocks may start to spread to other sectors of the stock market, according to Bank of America.
- According to the bank, here are four reasons why tech’s dominance could come to an end later this year:
The technology sector’s stock market dominance may finally come to an end later this year, according to Bank of America.
Driven by strong earnings growth, tech-oriented growth stocks have long been favored by investors over value stocks, despite a painful blip during the 2022 bear market.
Bank of America equity strategist Savita Subramanian argued in a Monday note that stock market returns could spread out through the fourth quarter of the year, favoring other sectors.
“If interest rates remain high (and as we highlight below, there are multiple reasons why interest rates and inflation will rise over the secular horizon), we would expect the S&P 500 to expand and greater returns to come from shorter-term equity duration vehicles (with higher near-term cash flows) rather than purely buying dream long-term growth stocks,” Subramanian said.
These are four reasons why Subramanian believes technology’s dominance is fading.
1. It’s all about the bottom line, not the economy
Since 2009, low interest rates, excess liquidity and weak economic growth have often been cited as immediate drivers of tech stocks, but ultimately it all comes down to earnings.
“Tech outperformed on profits and therefore outperformed,” Subramanian said.
But the revenue growth gap between tech and non-tech companies is finally starting to narrow, which should grab investors’ attention.
“As non-tech earnings accelerate, investors will become more price sensitive and seek cheaper earnings growth,” Subramanian said.
2. Long-term interest rates will be higher
“Clearly earnings are a key driver of outperformance, but rising interest rates could disproportionately hurt credit-sensitive long-term growth stocks, which offer higher cash returns and still trade at a high premium to their shorter-term peers,” Subramanian explained.
Subramanian said interest rates could continue to rise, or at least remain higher for longer than most expect, because demand for 10-year Treasuries from the Federal Reserve and foreign buyers such as China and Japan has waned.
Meanwhile, higher nominal GDP growth puts upward pressure on real interest rates, and US sovereign risk, as reflected in record debt-to-GDP levels, suggests higher returns are being sought from government bonds.
3. The current economic cycle favors circular leadership
According to Bank of America’s proprietary model, both the U.S. and European economies are showing signs of entering a first-stage “recovery” regime that has historically favored value stocks over growth stocks.
“Information technology and communications services lagged behind in past restoration arrangements,” Subramanian said, with the restoration rate standing at 44 percent.
4. The long-term beneficiaries of AI may not be in the tech industry
Technology stocks have been at the heart of the artificial intelligence (AI)-driven stock market rally, but that could change as AI adoption reaches saturation levels.
Shares of Nvidia and hyperscalers Microsoft, Amazon, Alphabet and Meta Platforms have soared as they invest heavily in AI-enabled GPU chips, but the gains are temporary, and any lasting gains may come from companies outside the technology sector that see long-term margin gains from integrating AI into their businesses.
“Capex recipients within the technology industry could see a temporary benefit,” Subramanian said, adding that a similar dynamic played out at Rockwell Automation during the coronavirus pandemic.
“After a three-year surge in automation spending during the COVID-19 pandemic, ROK became a core holding in active long-only funds with a 20% overweight. ROK is now 60% underweight in the average fund, while companies that grew on labour-light capex are being revalued. The services sector may ride the next wave of AI-driven disruption,” Subramanian said.
