Making sense of the tech sector sell-off: why shares in Microsoft, Nvidia and other AI enablers have pulled back

• Microsoft shares fall as cloud computing growth disappoints
• Nvidia among big-name tech shares falling in value
• More questions being asked about financial returns on AI investments
• Geopolitical tensions, election uncertainty and disappointing corporate results add to market jitters

"Investors are increasingly nervous about the tech sector and it only takes one small bit of bad news from a major player to increase anxiety levels across the market," says Dan Coatsworth, investment analyst at AJ Bell.

"Another sell-off involving the stocks that have contributed to much of the US market's gains in recent years was compounded by Microsoft's cloud computing business failing to meet growth expectations.

"It's no longer enough for the big tech companies to beat earnings or sales expectations. Each part of a business has to be moving with strength and stamina, otherwise the market will start finding fault.

"Expectations have arguably become too high for the so-called Magnificent Seven group of companies. Their success has made them untouchable in the eyes of investors and when they fall short of greatness, out come the knives.

"Other factors are at play with the tech sector sell-off, including geopolitical tensions and election uncertainty which have driven investors to bank some profits in stuff that's done well and reallocate money into more value-orientated stocks.

"Quite a few big corporates outside of the tech sector have also reported disappointing numbers, meaning investors are on heightened alert and that is driving adjustments to portfolios.

The rise of AI enablers

"Strong demand across multiple industries to deploy AI has created a new tailwind for the tech sector, particularly companies involved in the equipment or infrastructure needed to process or store large amounts of information. These so-called 'AI enablers' have enjoyed a ride akin to turning on the NOS taps in Fast & Furious - a burst of speed that has placed them at the front of the race.

"Many other companies have seen the positive market response to the big tech names and they've pushed hard on promoting the ways they plan to use AI to improve productivity, recognising it will grab investors' attention.

"There is a meme doing the rounds on social media that perfectly captures the situation. Leonardo DiCaprio's character from The Wolf of Wall Street challenges someone to give him a sales pitch that will entice him to buy a pen. The person responds by saying, 'It's AI powered', alongside a caption that says, 'Every company right now'. That is an accurate description of what we've seen over the past year, but companies might find that tactic no longer works.

The narrative is changing

"Euphoria around AI is now at risk of spluttering if more people ask when companies are going to generate positive returns from the significant investments made to support artificial intelligence technology. It's no longer good enough to simply say AI will be deployed.

"There is a fear that companies might take their foot off the pedal in terms of AI investments if there is more focus on the financial returns, meaning the AI enablers like Nvidia and Microsoft might lose the tailwind that has sent them to the moon in recent years.

"That hasn't happened yet, but it feels like the narrative is beginning to shift in the market. Just remember that the stock market is forward-looking and investors are pricing in what they think will happen next, not what is happening now or recently.

"As it currently stands, AI enablers are racing hard to keep up with demand. Microsoft's cloud growth has slowed because AI demand has outstripped its capacity, and that is not a new phenomenon. The capacity issue was flagged earlier this year and is expected to persist into 2025. For now, Microsoft is going to ride the AI gravy train as best as it can."