3 reasons tech stocks, once hot, are suddenly not

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A selloff in technology stocks Wednesday drove the Nasdaq and S&P 500 indices to their worst performances since 2022. The slump in high-tech follows a year-long rally by the "Magnificent Seven," a group of seven industry giants that have led markets into record terrain.

The slump continued on Thursday, with the tech-heavy Nasdaq index slipping 0.5% in morning trade. Chipmaker Nvidia shed 1.4% and Google-owner Alphabet fell 1.2%, while four other members of the group — Amazon, Apple, Meta Platforms and Microsoft — also lost ground. The only member of the group to gain on Thursday morning was Tesla, which rose about 3%.

The Magnificent Seven (sometimes called the "Mag Seven") fueled two-thirds of the S&P 500's growth last year, with investors betting that these companies would profit from their investments in artificial intelligence. But investors are now increasingly questioning whether the billions in capital funneled into the emerging technology will pay off anytime soon.

"The Magnificent Seven stocks now look like the "Lag" Seven," noted Piper Sandler analysts in a research note.

Here are three issues weighing on tech stocks.

Questions about AI profitability 

First and foremost, investors are increasingly concerned about whether the tech giants' massive investment in artificial intelligence will boost their bottom lines. Companies, as well as utilities and governments, are expected to spend a total of more than $1 trillion in the next few years on AI, according to Wedbush analyst Dan Ives. 

"[P]eople are starting to ask more questions about the economics of AI (what is the ROI on all this investment?)," wrote analysts at Vital Knowledge on Thursday. 

These questions were weighing on investors amid earnings reports this week from Tesla and Alphabet. While their quarterly earnings weren't disasters, they raised questions among investors about which other market heavyweights' financial results could fall short of expectations, said Sam Stovall, chief investment strategist at CFRA.

"How many disappointments are we likely to see? Maybe let's sell first and ask questions later," he said.

Great expectations can be hard to meet

Profit expectations are high for U.S. companies broadly, but particularly so for the Magnificent Seven. Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla need to keep delivering powerful growth after being responsible for most of the S&P 500's run to records this year.

Tesla was one of the biggest drags on stocks Wednesday, tumbling 12.3% after reporting a 45% drop in profit for the spring, and its earnings fell short of analysts' forecasts.

"[W]ith great outperformance comes great expectations, and the bar for this group was extremely high – therefore, what may look like a 'beat and raise' report on paper might actually be disappointing" for some stocks such as Alphabet, the owner of the Google search engine, Vital Knowledge said. 

An investor shift to smaller stocks

Lastly, investors are shifting money as part of a strategy called "sector rotation," according to John Lynch, chief investment officer for Comerica Wealth Management. This strategy involves investing assets based on changes in the business cycle, with investors switching into different types of stocks based on trends like inflation and profit growth. 

"Equity market leadership has experienced a dramatic shift in recent weeks," Lynch wrote in a recent report, noting that small-cap stocks have enjoyed a "significant' rally this month. 

The most recent inflation report, which showed U.S. prices cooling faster than expected, spurred some investors to shift money into smaller stocks because of the expectation that the Federal Reserve could soon cut rates. That could provide an outsized benefit to these businesses since they are more reliant on borrowing than bigger companies, Lynch noted.

—With reporting by the Associated Press.

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