A series by finews.com has different fund managers talking about New Year’s customs in their favorite cities or hometowns.
By Jonathan Curtis, Portfolio Manager of the Franklin Technology Fund
New Year's Eve in San Francisco is characterized above all by the breathtaking fireworks, which can be watched from «The Embarcadero», for example. But the Twin Peaks or one of the ships also offer a beautiful view.
Locals often celebrate at Ocean Beach, where they build a campfire at one of the fire pits. From there you also have a great view of the Golden Gate Bridge and the fireworks in the distance.
Four Key Factors For Strong Returns
Jonathan Curtis (Image: Franklin Templeton)
San Francisco is closely linked to technological innovation and Silicon Valley. Overall, the IT sector can look back on an eventful 2023, which we believe bodes well for another year of strong performance.
Four key factors could lead to strong returns for the sector: a turnaround in revenue and earnings growth after several quarters of pandemic-induced demand digestion, stable secular demand for digital transformation and the «application phase» of generative AI, a more stable inflation and interest rate environment, and reasonable valuations on a growth-related basis.
Confidence Above-Market Growth
Growth in the sector is expected to outperform the broader market. This is because the IT sector has become more disciplined and profitable over the past year as the cost of capital has risen and growth has slowed after the COVID-era's outsized demand.
After this period of IT budget cuts, companies now need to reinvest or risk falling behind in their digitalization initiatives. The signals indicate that this rationalization phase is turning into a stabilization phase and that a renewed acceleration is likely in 2024. This is reflected in the current market estimates for the sector's sales growth rates, which are well above the broader market (S&P 500).
Our confidence in above-market growth in the technology sector is further bolstered by strong demand for generative AI applications, which we believe will move into the «application phase» for enterprises in 2024.
Vast Amounts of Proprietary Data
We are currently in the «build and experiment» phase – a period of high R&D intensity and heavy capital expenditure that has benefited semiconductor, hardware, and cloud computing companies in 2023, including several of the so-called Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA and Tesla).
We are now seeing companies investing in the infrastructure and tools necessary to better utilize their vast amounts of proprietary data. This data can also be used in combination with generative AI models to dramatically improve productivity and customer experience.
In the application phase, we will see more practical cases and more technology companies using generative AI to increase the value of their product or service. We expect more companies from the lower end of the market capitalization spectrum to benefit in this transition phase, especially in industries such as software and internet services.
Sector Currently Not Overpaid
While the rally in 2023 saw an increase in the sector's valuation multiples, this widening of multiples has been concentrated in the large-cap companies and has generally coincided with an improvement in earnings expectations during the year.
Despite the sector's strong performance so far this year, we believe that investors are currently not overpaying for the sector's attractive long-term growth and quality characteristics.
