Is AI Behind the Tech Stocks’ Rally?

US indices rose last week, with the Nasdaq (US-TECH 100) hitting the highest level in nine months. On Thursday, May 18th,  the composite that measures the top 100 stocks on the Nasdaq exchange rose 1.5% to about 12,689, the highest since August 25, with the broad market supported by optimism over a debt ceiling deal. 

The Nasdaq index’s gains are believed to be driven by mega-cap tech stocks powering the equity market's impressive gains. Meta Platforms (META) and Nvidia (NVDA) gained around 67% and 118.3%, respectively, since the beginning of the year and up till now. Other strong performers include AMD (AMD) and Tesla (TSLA). In addition, since the start of the year, Apple (APPL), Amazon (AMZN), and Alphabet (GOOG) have gained 40.1%, 35.4%, and 37.4%, respectively.

What May Be the Main Drivers?

Investors have had a surge of interest in these large tech stocks by their strong performance, chatter around AI that has grown since the release of ChatGPT, and expectations that the Fed might soon start winding down its rate-hiking program.

Earnings reports for the first quarter have also helped boost stocks from mega-cap leaders, particularly Apple, Microsoft (MSFT), and Google parent Alphabet.

Apple's surge was driven by iPhone sales beating expectations for the reporting period. Microsoft provided positive guidance thanks to its AI drive towards sales growth, on top of earnings and sales above analyst expectations. Alphabet announced it would buy back $70B in shares. Meta had a difficult year in 2022, but its return to sales growth helped propel a rebound bolstered by better-than-expected earnings forecast for the next quarter.

Is Tech Back?

The tech-heavy Nasdaq's double-digit gain so far this year contrasts with a 9.2% gain for the broader S&P 500 (USA 500) index, while the Dow Jones (USA 30) grew just 0.8% in the same period. The large tech companies have been buoyant, with Apple rising enough so that its market capitalization surpassed Russell 2000 (USA 2000) for two weeks. That was the longest time on record.

Notably, the S&P 500's gain has been primarily driven by a small group of tech stocks focused on AI. Société Générale reported that without AI-focused stocks, non-AI stocks would be in negative territory this year. Among the companies driving the gains are Nvidia, Meta Platforms, Alphabet, and Microsoft, with a combined market cap of roughly 15% of the S&P 500's total market cap.

Not everyone is convinced about the tech rally, though. The head of the QQQ Trust, Anna Paglia, recently said she saw signs that investors are starting to take a defensive approach to tech mega-caps. She cited flat capital flows so far this year as an indication that there is not much conviction in the sector for the long term. 

AI: New Growth or Passing Fad?

Another fund manager who is not convinced that there is still much upside for mega-cap tech stocks is Fundstrat's Mark Newton, who says they are "certainly overbought", warning that they could stall out soon. However, he says that investors are optimistic about the sector “for the right reasons,” citing mega caps being safer stocks that can weather risks better and advancements in AI. 

Artificial intelligence has been this year's investment craze with potentially huge upsides for profits. Analysts at Bank of America (BAC) contend it's in a "baby bubble" for now, likening it to the dot-com bubble that drove the Nasdaq to new highs in 1999. Hype for AI remains strong, helping propel stocks such as Meta and Nvidia, and billionaires such as Bill Ackman dropping $1B into Alphabet to support AI development. But, the Bank of America analysts warn that the bubble could burst early if the Fed were to pause rate hikes and restart them. The report drew parallels to the dot-com bubble when the Fed resumed rate hikes, and the bubble burst nine months later.  (Source:Yahoo Finance)

Conclusion

Stock market performance in the US this year has been dominated by mega-cap tech stocks, with the tech-heavy Nasdaq rising over 3% last week in the context of the ongoing debt ceiling debate. Thanks to double-digit surges in the stock prices of large tech firms such as Apple and Alphabet, the Nasdaq composite has outperformed the Dow and S&P 500 this year. Can the AI craze continue, or is it time for investors to take the words of BAC and Mark Newton more seriously?