Key Insights:

• Despite AI’s surge, traditional tech sectors like software and IT consulting face slower growth and demand.
• Smaller tech firms outside AI are shrinking, with revenue and profit declines reported in recent quarters.
• Semiconductor demand driven by AI contrasts with weaker performance in auto and industrial markets.

Investor enthusiasm surrounding artificial intelligence (AI) continues to dominate the technology sector, masking underlying weaknesses that have persisted since the post-pandemic slowdown. While AI-driven companies such as Nvidia and Microsoft have experienced substantial share price growth, many businesses in traditional tech areas are still grappling with economic uncertainties and weak demand.

Recent financial data suggests that companies outside AI are facing prolonged challenges. Investors and analysts argue that the broader tech industry remains in a “recession” phase, particularly in areas with limited exposure to the AI boom.

Post-Pandemic Struggles in Traditional Tech Sectors

According to financial experts, sectors like software development, IT consulting, and electronic equipment manufacturing are experiencing slower growth. These industries have been affected by overexpansion during the pandemic, leading to overstocking inventories and overhiring. As demand has weakened, many businesses find it difficult to regain footing.

Tony Kim, head of technology investing in BlackRock’s fundamental equities division, expressed concerns about the limited growth in non-AI sectors. He commented, 

“When you look at technology outside of AI, there’s not much happening… Many [sub]-sectors are still in a recession.”

Similarly, companies like Asana, a business software provider, have had to scale back their growth forecasts for the rest of the year. Asana’s CEO, Dustin Moskovitz, cited economic uncertainty and the impact of AI as key factors affecting performance. 

“What we’re seeing in tech is still kind of the unwinding of the over-hiring and overspending that we saw at the beginning of the pandemic,” Moskovitz told analysts.

Slower Growth Among Tech Firms

Despite the excitement around AI, the broader tech sector’s growth has decelerated. An analysis of recent financial reports reveals that many large tech companies are growing slower than their historical averages. 

Data compiled by Bloomberg shows that companies within the S&P 500 IT sub-index increased their revenues by an average of 6.9% over the past 12 months, down from the five-year average of 10%.

Smaller tech companies, which are not benefiting from the AI boom, are struggling even more. In the Russell 2000, a small-cap index, the technology sector reported a 6.1% year-on-year decline in revenue for the second quarter of 2023, along with a 2.8% drop in profits, according to data from LSEG.

Tech strategist Ted Mortonson from RW Baird remarked on the broader downturn, stating, “Generative AI is masking a cyclical downturn in a lot of other core sectors.” Investors remain hopeful for improvements in the coming quarters, but some experts caution against relying on this optimism alone.

Semiconductor Sector Shows Mixed Performance

The semiconductor industry, which has seen significant demand from AI and data center computing, presents a more nuanced picture. While companies tied to AI development have seen strong growth, other sectors, such as automotive and industrial markets, have struggled.

Brice Hill, Chief Financial Officer of Applied Materials, a semiconductor equipment supplier, noted that while AI-related sectors are driving demand, certain markets are showing weakness. “We’re seeing particularly strong pull related to AI and data centre computing,” Hill said, “but there were pockets of weakness in the auto and industrial end-markets.”

Some investors seek stable companies within the semiconductor industry that can weather the current downturn while strategically investing in future technologies. John Barr, a portfolio manager at Needham Funds, explained,

“Current growth is not so great, so what we’re looking for are companies that have a stable business and are investing in something new.”

Prospects for a Shift in Investor Focus

As investor exuberance around AI begins to cool, there is speculation that attention may soon shift toward other sectors and corners of the technology industry. Some experts believe that a rotation of investment could favor areas that have been underperforming in recent months, such as financial services and industrial tech.

Within the tech sector, investors are hopeful that the worst-hit areas may soon stabilize. Tony Wang, portfolio manager for T Rowe Price’s science and technology fund, suggested that improvements in interest rates could provide relief to these struggling sectors. 

“I feel like the idea that AI is the only thing that is working has been the case for the last two years,” he stated. “I’m not sure it will be the case for the next two.”