A recent survey of market participants reveals that while technology stocks may see a broad advance this earnings season, a growing divergence is emerging between software and hardware companies, largely driven by the evolving landscape of artificial intelligence. The latest Markets Pulse survey, conducted from April 24-28 among 122 respondents, found that 65% believe the Bloomberg Magnificent Seven Index has further room to climb. However, opinions were divided on the extent of these gains, with artificial intelligence developments creating a clear split between software service providers and those manufacturing tangible technology assets.
Chipmakers Outpace Software Amid AI Boom
The performance metrics highlight this growing disparity. The VanEck Semiconductor ETF (SMH), valued at $58 billion, has experienced a significant rally since the beginning of 2023, including a notable 28% jump in the month preceding the survey. In contrast, the iShares Expanded Tech Software ETF (IGV), with $11.5 billion in assets, is coming off its weakest quarter since the 2008 financial crisis. Data indicates that chipmakers are outperforming software companies this year by the widest margin on record, as measured by the ratio between these two exchange-traded funds.
AI’s Double-Edged Sword for Software
Ted Koenig, Chairman & CEO of Monroe Capital, articulated this concern in a recent Bloomberg Television interview, stating, “AI risk is a real risk. Software that is more commoditized, where it can be developed easily and there’s low switching costs, that’s all at risk. You’re going to see those companies get hurt.” This suggests that software companies with less differentiated offerings or lower barriers to entry for competitors are particularly vulnerable to disruption and potential decline as AI capabilities mature and become more accessible.
Investor Focus on AI Capital Expenditures
As major technology companies prepare to report their earnings, investor attention is keenly focused on their artificial intelligence spending plans. A projected capital expenditure boom of $1 trillion over the next 12 months is expected to extend beyond the tech sector, influencing areas such as energy infrastructure, according to Bloomberg Intelligence data. Despite the significant investment, more than half of the survey participants expressed disagreement or strong disagreement that companies’ AI expenditures are adequately justified by the expected returns. Nevertheless, the proportion of those who agreed with the justification for AI spending rose to 41% in the latest survey, up from 38% in an October poll, indicating a slight but discernible shift in sentiment.
JoAnne Feeney, a portfolio manager and partner at Advisors Capital Management, remains optimistic about the long-term prospects, noting, “We believe that this AI buildout has years to go on the power of the related sales and earnings growth alone. These stocks should continue to climb.” This perspective suggests that the current AI investment cycle is in its early stages and is expected to fuel sustained growth for the companies involved.
Rising Costs and Market Resilience
Elevated input costs, encompassing both physical components and energy, were identified by survey participants as the primary risk factor anticipated for tech companies during the current reporting period. The energy-intensive nature of chipmaking, in particular, has raised concerns about potential output curtailments as costs escalate. Despite a roughly 48% increase in WTI crude prices since the onset of conflict in Iran, technology stock gains have managed to cushion the broader U.S. equity market. Bloomberg strategists observe that while historically high oil prices have presented challenges for risk assets, the current AI cycle is lending unusual resilience to equities.
The divergence between chipmakers and software providers, driven by the complex interplay of AI development, capital expenditure, and rising costs, is set to be a key theme for investors navigating the technology sector. While the demand for AI-powered hardware continues to surge, the future for certain software segments appears more uncertain, creating a bifurcated market outlook.
