On September 9, Cailian Press (Editor: Xiaoxiang) reported that Warren Buffett has a famous saying: "When the tide goes out, you can see who is swimming naked." However, now, as the wave of AI gradually subsides, people can't help but notice that there seems to be a lot of "naked swimming" in the technology industry.

Industry insiders' recent analysis of the second-quarter financial reports shows that the enthusiasm for artificial intelligence actually masks the weakness of many companies in the technology industry. Since the slowdown in performance in 2022, many companies have "remained in decline."

In the past year and a half, large companies such as Nvidia and Microsoft, which are expected to be early beneficiaries of artificial intelligence, have seen their stock prices soar, helping people erase the terrible memories of 2022, when the technology-dominated Nasdaq Composite Index fell by nearly one-third. However, beneath the surface, many technology companies that have not focused on artificial intelligence have been struggling to regain momentum.

Tony Kim, investment director of fundamental equities at Blackrock, said that when you look beyond artificial intelligence in the technology sector, you will find that there has not been much progress. Many (sub)industries are still in decline. The only sector that is truly growing is artificial intelligence.

Beneath the surface of the AI wave

For example, software, IT consulting, and more traditional technology fields that produce electronic devices for industries such as manufacturing and automotive are still facing challenges, including weak demand and the aftermath of excessive expansion and inventory buildup during the COVID-19 pandemic.

Some companies are even bearing the negative impact of the AI wave as budget-constrained customers realign their investment direction.

Last week, Dustin Moskovitz, the co-founder of Facebook and current CEO of Asana, summarized the situation of many companies, indicating that the commercial software group has reduced its performance forecast for the second half of this year. Moskovitz said, "What we still see in the technology sector is the lingering effect of over-recruitment and overspending from the early days of the epidemic. I believe all of this is related to the enormous uncertainty in the economic environment. Also, there's the question of how artificial intelligence will develop."

Recent financial reports show that the growth rates of most large technology companies are slower than in the past, while many smaller technology companies are actively scaling back.

Industry data shows that the average revenue of companies in the S&P 500 Information Technology Index has only grown by 6.9% over the past 12 months, compared to an average growth rate of 10% over the past five years. About three-quarters of the companies are growing at a slower rate than the recent average. Over the past 12 months, the average earnings per share of component stocks in the index increased by 16%, lower than the 21% over the past five years.

(S&P 500 Information Technology Index)

In fact, the signs of weakness in technology companies in the small-cap index are even more pronounced, as the resurgence of large technology stocks has hardly provided any boost to small technology stocks. According to LSEG data, technology stocks in the Russell 2000 Index were the second worst-performing sector in terms of revenue growth in the second quarter: a year-on-year revenue decline of 6.1% and a profit decline of 2.8%.

RW Baird's technology industry strategist Ted Mortonson stated that generative artificial intelligence (AIGC) has masked the cyclical decline of many other core industries.

Even in sub-industries such as chips, which are attracting enthusiasm for artificial intelligence, some business lines are struggling. For example, the CFO of traditional chip equipment supplier Applied Materials, Brice Hill, stated last month, "We see particularly strong traction related to artificial intelligence and data center computing, but the automotive and industrial end markets are facing weakness."

John Barr, portfolio manager at Needham Funds, also pointed out that the situation is similar across the industrial sector. He has invested in several semiconductor companies, including Applied Materials. "The current growth momentum is not very good, so what we are looking for are companies with stable businesses that are expanding into new areas."

Can 'Small Cap Rotation' happen?

It is worth mentioning that since early summer, the enthusiasm of some investors for companies focused on AI has waned, leading many critics to predict that investors' attention will gradually shift from large tech stocks to financial services and industries. This may bring some solace to companies in the tech industry that have been struggling in recent years.

Some tech industry experts hope to see a 'small cap rotation' within the tech industry, similar to the market rotation this summer, shifting from the largest AI stocks to the less favored corners of the industry.

And while few companies have achieved triple-digit growth like Nvidia in recent quarters, there are indeed signs that some of the worst-performing sectors in the tech industry are experiencing a turnaround.

In response to this, Tony Wang, portfolio manager of the T Rowe Price Tech Fund, said, 'I think we are seeing a stable trend: in sectors sensitive to the macro economy, the situation is no longer deteriorating, and lower interest rates could help.'

'I think that over the past two years, people have always thought that artificial intelligence is the only technology worth investing in. But I'm not sure if the situation will be the same in the next two years.'