This article was originally produced in conjunction with Boring Money for their Investment Trust Hub.

Some information contained herein has been obtained from third party sources and has not been independently verified by Polar Capital. Neither Polar Capital nor any other party involved makes any express or implied warranties or representations.

‘AI’, the abbreviated word for artificial intelligence, was crowned 2023’s Word of the Year by Collins Dictionary. It’s perhaps unsurprising that the term made the cut in the midst of a year awash with AI-related discussion, from ChatGPT’s meteoric rise to Bard’s infamous launch demo mistake – all the way to the Beatles’ reanimation of archived John Lennon recordings to release one final song.

The hype around AI wasn’t limited to the world of lexicography either; it helped to drive one of the best annual performances for tech stocks in two decades. After a disappointing streak in 2022, the tech-heavy Nasdaq index finished 2023 up +43% (all figures in USD terms), marking its best year since 2020 and just shy of its performance in 2009 - the two years with the largest gains since 2003, when tech stocks were reemerging after the dot-com crash.

Much of the sector’s success in 2023 can be attributed to the so-called “Magnificent Seven” – mega-cap tech companies Microsoft, NVIDIA, Amazon, Google, Apple, Tesla and Meta (Facebook). These companies dominated throughout the year, with plush performances from the likes of Meta, up more than 177%, and Nvidia, which soared an eye-watering 232% between January 2023 to January 2024.

However, some recent wobbles have called into question whether tech stocks can maintain this momentum throughout 2024. The chaotic firing and then rehiring of Sam Altman, CEO of OpenAI (the company behind ChatGPT), provided a peek at brewing boardroom drama in Silicon Valley, whilst questions remain over whether 2023’s stellar results were in fact the result of a natural recovery from their substantial slump the year before.

A whirlwind ride for tech stocks in 2023

Commenting late last year, Ben Rogoff, Fund Manager at the Polar Capital Technology Trust, acknowledged that there was more to the sector’s dizzying ascent in 2023 than what meets the eye.

While Magnificent Seven returns have been exceptional, this in part reflects a very depressed starting point following exceptionally poor performance in 2022, when the group fell c40%

Indeed, after the Nasdaq and Dow Jones U.S. Technology Index both fell more than 30%, 2022 became “a year of reckoning” for the sector, when persistent outperformance appeared to finally catch up to tech stocks – dragging global markets down with them.

This left a sour taste in the mouth at the start of 2023. In its outlook for the year in January, Harvard Business Review took a decidedly downbeat punt on the direction of the sector: “2023 will likely be a more sober year in tech. Geopolitical and economic uncertainties are injecting more caution into the next phase of tech’s evolution. Leaders will have to search for ways to do more with less, find value where innovations overlap, and strategically invest in technologies that are hitting a tipping point.”

At the same time this forecast was published, OpenAI’s transformative AI-powered chatbot ChatGPT was just starting to trickle into the headlines following a launch at the tail-end of 2022. Within two months, the software had racked up over 100 million users and helped drive OpenAI's valuation at $29 billion within just 8 weeks of ChatGPT’s public release. Today it’s often credited with triggering the start of the AI boom, with an unprecedented level of consumer interest and investment in the sector.

As AI and broader tech stocks went from strength to strength throughout 2023, sentiment shifted to a more positive note. In its mid-year outlook, consultancy giant McKinsey & Company remarked: “The first half of 2023 has seen a resurgence of enthusiasm about technology’s potential to catalyze progress in business and society.” And it gave a specific nod to the impact of new AI technology, stating: “Generative AI deserves much of the credit for ushering in this revival.”

By the end of 2023, the AI-fueled frenzy had officially taken hold. The Magnificent Seven stocks alone delivered more than double the S&P 500’s returns and Forbes Advisor closed the year with a hopeful statement: “It seems inevitable that AI will play an increasingly important role in the future economy, and investors appear to recognize the market is still in the early innings of a long-term AI technology boom.”

Can tech keep on ticking?

The big question for 2024 is whether technology stocks will be able to maintain this momentum, or if last year’s bumper performance will give way to overly optimistic and unsustainable valuations – and the potential for a price correction.

This dilemma was already at the front of analysts’ minds before the New Year. In December 2023, Rob Haworth, Senior Investment Strategy Director at U.S. Bank Wealth Management, said: “Tech companies are generating earnings, but valuations of many tech stocks have been driven higher, so the question in 2024 is whether they can maintain earnings growth that lives up to current stock prices.”

And like last year, it seems that all eyes are once again on AI.

AI offers the potential to lead to much more innovation and greater efficiencies,” Haworth said, but cautioned: “We know it’s a useful technology, but there are questions about how to monetize it. We don’t really see significant AI-only technology companies so far in today’s market.

This is a salient point. After all, many of the technology firms behind the biggest AI tools belong to large, well-established brands. For example, ChatGPT was developed by OpenAI (which is part-owned by Microsoft) and Bard was created by Google. Both these companies are enormous, multi-pronged firms which have established lines of business beyond AI – and therefore aren’t wholly reliant on AI success to sustain earnings.

Haworth warned that: “Successful AI launches can boost a company’s earnings, but not be the sole determining factor.”

The next phase of evolution

Nevertheless, there remains a vocal group who believe that tech stocks still have much more to give – and that the current “hype” is in fact the stirrings of a long-term, upward trend. Among them is Rogoff, who points out that the team behind the Polar Capital Technology Trust have long anticipated the opportunity in AI, with it having been a core theme within the portfolio for a number of years’ already.

“While there may have been a rush of excitement around AI this year, the Technology team here at Polar Capital has long recognised the potential of AI,” Rogoff says. “The belief then was that AI would always become mainstream; the question was ‘When?’, and it would appear the answer is ‘Now’.”

He adds that the potential for AI to disrupt and transform not just the technology sector, but the world at large, is a core interest for the Polar Capital Technology Trust’s investment strategy going forwards.

For us, generative AI represents one of the most exciting technological breakthroughs we’ve seen and could well be more important than the advent of the internet or cloud computing

So what of the concerns of more skeptical investors – overhype, unsustainable momentum, a price correction on the horizon? Some analysts are firm in their conviction that a near-term correction is coming. Peter Garnry, Head of Strategy at Saxo Bank, stated in November last year: “The sector is overhyped in the short term and there will be a meaningful correction in AI-related stocks”.

However, the unifying message emerging from analysts – optimists and pessimists alike – is that AI is the future. Garnry conceded: “We remain pretty optimistic in the long term.” And Rogoff takes the view that recent results, though seemingly bullish, are nevertheless rooted in strong foundations.

“We have not yet experienced the same overexuberance as seen in previous hype-driven cycles,” he says.

Moreover, there is a difference between so-called hype and genuinely backing a transformative technology. Just as the Bessemer process in the nineteenth century created an inexpensive way to mass produce steel, leading to the creation of myriad new industries, there is no telling what AI will facilitate from here. However, we are confident that the opportunity is vast given that AI is able to automate c25% of human tasks today with the potential to impact as many as 300m jobs globally.”

Is it too late to invest in tech?

So is there still time to invest in tech, or is the wave already breaking? Ben Rogoff, Fund Manager at the Polar Capital Technology Trust, says: While there have been strong returns in some of the highest profile AI enablers, valuations of key AI stocks have generally been backed up by robust earnings growth. Investors have been relatively selective rather than boosting the share prices of all firms riding on the sector’s popularity. We expect the market to broaden in 2024.”

But for any investors still worried they’ve been missing out, they might be surprised to find that they’ve actually been part of the AI boom along, according to Jason Hollands, Managing Director of Bestinvest.

“You may have exposure even if you don’t hold any of these funds,” he says, thanks in part to the prevalence of the Magnificent Seven.

We have little doubt that AI-related productivity gains are likely to prove very significant and as such that we are in the early stages of a major new investment cycle.

He cautions investors to check their existing holdings before plunging into any new AI investments, as you run the risk of duplicating and diluting the diversification of your overall portfolio: “By purchasing a specialist AI-themed fund today, you may simply be doubling up in many of your existing holdings”.

Rogoff adds that anyone investing in tech stocks – and AI in particular – should seek to understand the long-term potential of the sector. There is a reasonable (and for many, expected) chance of wobbles in the short-term, but the overall outlook for technology remains bright. Perhaps brighter than ever.

“While there could be setbacks or disappointments along the way,” Rogoff concedes, he concludes that: “We remain AI maximalists. We have little doubt that AI-related productivity gains are likely to prove very significant and as such that we are in the early stages of a major new investment cycle. In addition, no major global economy/government can afford to stifle domestic innovation and lose talent given the stakes at play in the global AI race now underway.”

“With the market and rates appearing more benign, we expect the pace of AI adoption to prove a key determinant of sector fortunes during 2024.”