Is the Technology Sector Poised for a Rebound in 2023?

Technology stocks had a rough 2022. Within the S&P 500, the technology sector declined by almost -30% last year, as compared to a roughly -19% decline for the broad index. One of the key culprits driving technology’s large relative decline in 2022: rising interest rates.

At the beginning of 2022, technology stock valuations were hovering around all-time highs, and interest rates were essentially anchored to the zero bound. But as readers know, inflation soared to 40-year highs, which prompted the Federal Reserve to raise rates quickly. Higher interest rates discount the value of future earnings, which made ‘expensive’ technology companies with longer-term cash flows look less attractive to, say, value companies.¹

Higher interest rates also make borrowing more expensive, which can compromise future profits for growth companies that rely on borrowing to fund growth and expansion. As investors become less optimistic about the future growth potential of a company, price pressures can follow. It’s also true that when interest rates rise, fixed-income investments such as bonds can become more attractive to investors, especially if the outlook for economic growth is mixed.

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Fast forward to 2023, and technology stocks have sold off sharply from highs, pushing valuations back down to levels historically consistent with 4-5% rates on the 10- and 30-year U.S. Treasury bonds. In other words, technology stocks have reset to what we might consider a fresh starting point.

The question then becomes: what is the outlook for the technology sector from here, and what’s driving optimism in the space? We have three factors investors should watch:

1. Profit Margins Could Strengthen in 2023

Following a challenging year for earnings and stock performance in 2022, tech CEOs have sharpened their focus on managing costs. Many early-stage companies had grown accustomed to abundant and easily accessible funding in the months and years after the pandemic, which dried up in 2022. Now, we’re seeing more focus on cost-cutting and a focus on maintaining and growing profit margins versus ‘growth at all costs.’ Case in point: technology companies accounted for a lion’s share of layoff announcements last year.

A high-profile example of a company prioritizing margins over growth is Meta (formerly known as Facebook). CEO and founder Mark Zuckerberg has declared 2023 the “Year of Efficiency” for Meta, which has been followed by tens of thousands of layoffs and a scrapping of 5,000 job openings. Over-hiring in the wake of the pandemic brought Meta’s annual revenue per employee to $1.35 million, an -18% decline from 2021. Meta’s goal in 2023 is to reach a record $1.85 million per employee level.

2. New Innovation Could Supercharge Growth

The release of Open AI’s “Chat GPT” tool has made waves in the media and among industry stakeholders, with many declaring that “generative AI” tools could be as impactful to future economic growth as the internet in the 1990s. These AI tools can write text, draw pictures, write code, and more – all at a level equal to or greater than most humans.

The implications for economic growth and the labor market are many, but here are five areas where AI could have the biggest impact on the economy:

1. Automation of Routine Tasks: AI tools can automate routine tasks, allowing workers to focus on more creative and strategic tasks. This can increase productivity and efficiency, leading to cost savings for businesses and the creation of new jobs that require higher-level skills.
2. Optimization of Business Processes: AI can analyze vast amounts of data to identify inefficiencies in business processes, allowing companies to streamline their operations and reduce costs. This optimization can lead to new job opportunities, such as data analysts, process improvement specialists, and automation engineers.
3. Personalization of Customer Experience: AI can analyze customer data to provide personalized recommendations and experiences, increasing customer satisfaction and loyalty. This can lead to the creation of new jobs in customer service and marketing, as businesses strive to provide a more personalized experience.
4. Predictive Analytics: AI can analyze data to identify patterns and make predictions about future trends. This can help businesses make better decisions about investments, production, and marketing, leading to increased profitability and the creation of new jobs in data analysis and prediction modeling.
5. Development of New Products and Services: AI can help businesses develop new products and services by analyzing customer data and identifying unmet needs. This can lead to the creation of new jobs in product development, marketing, and sales.

Overall, AI can provide significant benefits to businesses and the economy by improving efficiency, reducing costs, and creating new job opportunities. With new economic growth comes investment opportunities.

3. Interest Rates Appear Likely to Peak

If rising interest rates had a negative impact on growth stocks and in particular, technology stocks, then it follows that peaking (and potentially falling) interest rates could function as tailwinds.

We’ve seen this pattern play out so far in 2023, with technology stocks rallying as issues in the banking sector made headlines. The basic thesis was that investors were betting that problems in the banking sector would impact economic growth to the point that the Fed may not need to raise rates much more to cool the economy and inflation. A belief that interest rates could peak in 2023, and perhaps even fall, should continue to drive enthusiasm for tech stocks.

Bottom Line for Investors

Leadership changes hands in the market often, and we’re coming off a year where technology stocks were among the worst performers. Cyclicality alone could make a good case for tech stocks looking ahead, but there are also the potential tailwinds of cost-cutting, profit margin focus, growth runway driven by AI, and peaking interest rates that arguably are working in tech’s favor this year.

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• How to create a truly well-diversified portfolio

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¹ Black Rock. March 8, 2023.

² Zacks Investment Management may amend or rescind the A Better Way Forward: Actively Managing Passive Index Funds guide offer for any reason and at Zacks Investment Management’s discretion.

³ Zacks Investment Management may amend or rescind the A Better Way Forward: Actively Managing Passive Index Funds guide offer for any reason and at Zacks Investment Management’s discretion.

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