U.S. tech stocks have been firing on all cylinders for the last two years, riding on an artificial intelligence (AI) boom. Although there were occasional dips due to higher rates, tech stocks efficiently recouped those losses and kept up their winning momentum. Their momentum couldn’t be hurt by rising rate worries last year.
The technology exchange traded fund (ETF) Technology Select Sector SPDR Fund XLK has advanced 28% so far this year (as of Dec. 5, 2024) and jumped 56% in 2023. Now what awaits next year?
What Lies Ahead of Tech ETFs in 2025?
Tech is the New Normal
“New normal” trends like work-and-learn-from-home and online shopping, increasing digital payments and the growing video-streaming scenario are sure to stay for long. The growing adoption and the ongoing emergence of AI, machine learning and IoT are the winning areas. A strong focus on AI techniques and the home automation space should favor the technology sector.
AI Boom in Fine Fettle
After a solid performance in 2024, the AI rally continues. In a 2024 McKinsey survey, 39% of respondents saw lower costs resulting from AI adoption in their organization, according to Forbes. This means that over the long run, the AI business may prove to be at least a volume-driven revenue engine, if not realization-driven. Meanwhile, big tech companies are making AI investments in full stride, sensing the potential.
Surging Software Demand
The demand for software remains strong, as enterprises spend big on artificial intelligence. “The AI revolution is accelerating, and now it’s the software sector that will benefit from the use-case phase of AI, set to be primetime in 2025,” said Wedbush analyst Dan Ives (read: Software Stocks & ETFs: Next Big AI Opportunity?).
Trump 2.0 Looks Moderately Favorable
The re-election of Donald Trump infused record highs in technology and cryptocurrency markets. His administration is expected to address issues like antitrust, AI regulation, and the CHIPS Act, which have major implications for Big Tech.
Under the Biden administration, antitrust measures targeted big players like Google, Amazon and Apple, with the FTC attempting to curb their market dominance. Trump, however, has indicated a more lenient stance on breaking up Big Tech. Historically, the Trump administration has been inclined to boost AI measures. Biden’s CHIPS Act is also not likely to be repealed in the Trump era (read: What's in Store for Big Tech ETFs in Trump 2.0?).
Is Overvaluation a Concern?
The Technology Select Sector SPDR Fund (XLK) has a price-to-earnings (P/E) ratio of 45.46X. Given the 24.7X median P/E ratio (10 year) of XLK, we can conclude that the current valuation is pricey. Hence, digging into undervalued tech stocks and ETFs would be a great idea going into 2025.
Against this backdrop, below we highlight a few tech ETFs that have a Zacks Rank #1 (Strong Buy) or 2 (Buy), P/E (36 months) less than 30X and past-month price gains of at least 10% (as of Dec. 5, 2024).
Undervalued High-Momentum Tech ETFs in Focus
First Trust Dow Jones Internet ETF FDN – Zacks Rank #1; P/E: 29.87X; One-month price gain: 13.9%
The underlying Dow Jones Internet Composite Index includes only companies whose primary focus is Internet-related. The ETF charges 51 bps in fees.
First Trust Technology AlphaDEX ETF FXL – Zacks Rank #1; P/E: 25.76X; One-month price gain: 12.4%
The underlying StrataQuant Technology Index is a modified equal-dollar weighted index designed by the AMEX to objectively identify and select stocks from the Russell 1000 Index that may generate positive alpha relative to traditional passive style indices through the use of the AlphaDEX screening methodology. The ETF charges 62 bps in fees.
Invesco S&P SmallCap Information Technology ETF PSCT – Zacks Rank #2; P/E: 27.28X; One-month price gain: 12.2%
The underlying S&P SmallCap 600 Capped Information Technology Index measures the overall performance of common stocks of U.S. information technology companies. The ETF charges 29 bps in fees.
SPDR S&P Software & Services ETF XSW – Zacks Rank #2; P/E: 28.59X; One-month price gain: 20.5%
The underlying S&P Software & Services Select Industry Index represents the software sub-industry portion of the S&P Total Stock Market Index. The S&P TMI tracks all the U.S. common stocks listed on the NYSE, AMEX, NASDAQ National Market and NASDAQ Global Select Market. The Software Index is a modified equal-weighted index. The ETF charges 35 bps in fees.
Bottom Line
Overall, the AI rally seems to have more room for growth. Plus, the start of the Fed rate-cutting cycle from September 2024 should act as another positive for this growth-oriented investing area. Only, high valuation could be a glitch, for which the above-mentioned ETFs could come across as solutions.
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Technology Select Sector SPDR ETF (XLK): ETF Research Reports
First Trust Technology AlphaDEX ETF (FXL): ETF Research Reports
Invesco S&P SmallCap Information Technology ETF (PSCT): ETF Research Reports
First Trust Dow Jones Internet ETF (FDN): ETF Research Reports
SPDR S&P Software & Services ETF (XSW): ETF Research Reports
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