13 Jun 2024
Tech stocks have continued to perform well in 2024 relative to the broader market, but there has been wide divergence in returns, even among the ‘Magnificent 7’. Fidelity Global Technology portfolio manager Hyun Ho Sohn outlines why tech themes could broaden out beyond recent high profile winners and discusses some of the underappreciated opportunities he sees across the sector.
The ideas and conclusions here do not necessarily reflect the views of Fidelity’s portfolio managers and are for general interest only. The value of investments can go down as well as up, so your clients may not get back what they invest.
Overall, technology stocks have done well in 2024, both on an absolute basis and relative to the broader market. However, within the sector, there has been a wide divergence in performance. Large-caps significantly outperformed small-caps, and semiconductor stocks have delivered excellent returns. Software and internet stocks have also done well, while sub-sectors such as hardware, communications equipment, and IT services performed poorly. We saw divergence even within the 'Magnificent 7' mega caps, with Nvidia and Meta leading the rallies while Apple and Tesla lagged.
The portfolio has tended to underperform in market environments where strong investment themes drive extended sector momentum and elevated risk appetite. Good examples of this are the current AI and recent Covid-beneficiary themes. Over the first four months of the year, for example, it is therefore unsurprising that relative performance has been hit by underexposure to AI semiconductor and equipment stocks, including Nvidia, Broadcom, and ASML.
Our approach throughout has been consistent, looking to invest in companies with underappreciated long-term earnings power, frequently in less-followed segments such as the small/mid-cap space. We believe following consensus and momentum carries a lot of risk and a high premium that’s not worth paying. Even astute investors find it difficult to predict the future, so minimising risk when things go wrong is as essential for us as making money. This has proven to be a prudent strategy and is a key part of our strong long-term performance record.
The overall earnings picture was mixed, although we did see upgrades across the sector. On the positive side, mega- cap companies delivered solid results. Healthy digital advertising demand boosted Meta and Alphabet, while digital media subscription businesses such as Netflix and Spotify benefited from continued user growth and price increases. Robust results for Microsoft and Amazon’s hyperscale data centre businesses reflected accelerating cloud demand. Investment in AI infrastructure remains strong, and almost every hyperscale company has increased its capital spending plans, benefitting semiconductor businesses like Nvidia and TSMC.
On the other hand, macro uncertainties are impacting some businesses. Although there are signs of stabilisation in hardware component and broad-based semiconductor businesses, the pace of recovery remains slow, and inventory levels in the communications equipment and electric vehicle value chain stay above average. With so many companies prioritising discretionary IT, projects keep getting pushed back, leading to weak results at many IT services companies and some software businesses.
Many of the stocks viewed by the market as AI winners – Nvidia and other semiconductor and hardware companies – are priced for perfection. From a risk/reward perspective, this makes them unattractive. The market expects a massive AI infrastructure buildout without any speed bumps, but despite generative AI’s long-term potential, there are also under-appreciated risks.
There are positive signs of generative AI adoption in digital media, creative industries, and consumer internet – where the uptake of new technology tends to be quick. For many large enterprises, however, particularly in regulated industries such as financial services, many generative-AI projects remain at the proof-of-concept stage.
Despite rapidly falling AI computing costs, there are many areas where those costs remain too high for mass adoption. Training large language models requires cutting-edge data centre infrastructure and consumes massive amounts of electricity, which could become a bottleneck. Given the cyclical nature of capital spending, if generative-AI adoption hits a speed bump, AI infrastructure demand will be hit even harder.
That said, there are still plenty of under-appreciated AI beneficiaries. We are looking at businesses that don’t rely on rapid AI adoption and view generative-AI as a long-term growth driver. For example, Amazon’s cloud computing business is doing well as customers continue modernising their IT stack regardless of the AI adoption curve. TSMC’s semiconductor manufacturing business will benefit irrespective of which AI silicon outperforms or which customer does better. IT consulting services will also benefit from helping customers adopt AI in specific industries.
IT consulting, data infrastructure, and cloud computing are under-appreciated long-term beneficiaries of the AI era. Elsewhere, payment services and networks are essential parts of the technology stack for e-commerce and omnichannel retail. Companies with the right scale and technology advantages will capitalise on these long-term growth opportunities.
Elsewhere, we still think that on-demand media and music streaming remain under-monetised, with industry leaders well-positioned to benefit from further consolidation.
We are also increasingly positive on small/mid-cap software companies, given the reviving appetite for M&A from both strategic acquirers and private equity firms. There have already been many confirmed deals and unconfirmed interest in areas such as data and design software, and we are finding more new ideas in this space
We are overweight in China. From a top-down macro and geopolitical standpoint, China is a difficult market to be comfortable in, but from a bottom-up perspective, there are good companies with attractive risk/reward profiles.
Tencent and Alibaba remain attractive; regulatory risks have reduced, valuations have become attractive, and their capital allocation (including shareholder returns) has improved significantly. Trip.com, a leading online travel agent, has strong potential to grow internationally. KE Holdings, a leading online and offline real estate broker, has a long growth runway as the sector is in the early stages of digitisation.
We are actively seeking new opportunities in China but are also mindful of geopolitical and regulatory tail risks. As a result, we are keeping individual position sizes and overall exposure manageable.
Looking ahead, for the rest of 2024 we expect technology sector performance to broaden out beyond the dominant AI theme, given the number of underappreciated opportunities in the value chain.
The reacceleration of the cloud will provide a tailwind for cloud infrastructure and software, while sub-sectors such as analogue semiconductors, IT services, and communications equipment are in the process of bottoming, with attractive valuations. Given the elevated spending level and the slower-than-expected pace of generative-AI adoption, we see risks in some AI stocks.
Overall, we remain constructive on the sector, and our bottom-up stock-picking and disciplined investment approach will be critical throughout the rest of the year.
Fidelity Global Technology Fund - performance overview
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Past performance is not a guide to the future.
Source: Fidelity International, 30 April 2024. Comparative Index: MSCI ACWI Information Technology Index (Net). Holdings can vary from those in the index quoted. For this reason the comparison index is used for reference only. Performance is net of fees in GBP terms for W-ACC-GBP share class which was launched on 11 March 2014*. Basis: Nav-Nav with gross income reinvested in GBP. Hyun Ho Sohn was appointed portfolio manager on 31 March 2013.
Important information
This information is for investment professionals only and should not be relied upon by private investors. Investors should note that the views expressed may no longer be current and may have already been acted upon. Changes in currency exchange rates may affect the value of an investment in overseas markets. Investments in emerging markets can be more volatile than other more developed markets. The Fidelity Global Technology Fund has the potential of having high volatility either due to its composition or portfolio management techniques. It can also use financial derivative instruments for investment purposes, which may expose it to a higher degree of risk and can cause investments to experience larger than average price fluctuations. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only.