Can ASX 200 tech shares produce another strong performance in FY25?

Is the tech sector capable of beating the overall ASX share market in the next 12 months?

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S&P/ASX 200 Index (ASX: XJO) tech shares delivered strong returns in FY24. There are multiple quality names within the ASX 200 that have created value for shareholders.

Some of the biggest names in the tech sector include Wisetech Global Ltd (ASX: WTC), REA Group Ltd (ASX: REA), Xero Ltd (ASX: XRO), CAR Group Limited (ASX: CAR), SEEK Ltd (ASX: SEK) and TechnologyOne Ltd (ASX: TNE).

The performance of each individual company's operational growth and financials will obviously have an impact on how the share prices of the ASX 200 tech shares track in FY25. Aside from that, I think there could be two (foreseeable) important factors.

Interest rates

Interest rates usually greatly impact valuations because if investors can get a good return from safe assets like bank accounts and bonds, then 'risk' assets like shares should be priced at a lower level. For example, high interest rates, in theory, should mean a lower price/earnings (P/E) ratio than if interest rates were lower.

One of the world's greatest investors, Warren Buffett, once said:

The value of every business, the value of a farm, the value of an apartment house, the value of any economic asset, is 100% sensitive to interest rates because all you are doing in investing is transferring some money to somebody now in exchange for what you expect the stream of money to be, to come in over a period of time, and the higher interest rates are the less that present value is going to be. So every business by its nature…its intrinsic valuation is 100% sensitive to interest rates.

Some investors may have already 'priced in' interest rate cuts from the US Federal Reserve or the Reserve Bank of Australia (RBA) which is likely partly why we saw such a strong rally of ASX 200 tech shares during FY24.

Based on Australia's latest inflation numbers and RBA commentary, it could be a while yet before there's a rate cut.

Valuations too high?

Interestingly, some high-profile, high-performing investors have started reducing their exposure to technology.

The Australian Financial Review recently reported that fund manager GQG Partners Inc (ASX: GQG) has made some "aggressive moves" to produce the next stage of strong returns (in FY25).

The newspaper reported that tech stocks were a major factor in GQG's recent investment fund performance. However, in the last few months, the fund has reduced its exposure to the tech sector by more than half – from 43% in the portfolio to 21%. This decision was made because it seemed that the significant market interest in AI stocks was not spreading to other sectors as widely as expected.

GQG's Brian Kersmanc said:

From the semiconductor standpoint, things weren't broadening out as much –
spending was really isolated to that cluster around AI and data centres.

Markets also started pricing in some really blue sky scenarios for these stocks, so
although optically they looked cheap on a price-to-earnings basis, to get to the
estimates that were prevailing in the market, you had to get to some pretty
aggressive assumptions.

The last time GQG significantly cut its tech exposure was when it rotated into energy stocks, according to the AFR. After that, the NASDAQ plunged 33%, and commodity prices soared after Russia invaded Ukraine. The ASX 200 tech shares also had a bad time in 2022.

It's an interesting sign that GQG has decided to take profits from its tech exposure. Even if tech stocks don't crash in FY25, this could suggest that the ASX 200 tech shares may not see the same level of returns in FY25 as FY24 because we've already seen the expansion of their valuations (such as the P/E ratios).

Better-than-expected earnings growth and/or reducing interest rates could be necessary for another good year.

Motley Fool contributor Tristan Harrison has no position in any of the stocks mentioned. The Motley Fool Australia's parent company Motley Fool Holdings Inc. has positions in and has recommended REA Group, Technology One, WiseTech Global, and Xero. The Motley Fool Australia has positions in and has recommended WiseTech Global and Xero. The Motley Fool Australia has recommended Car Group, REA Group, Seek, and Technology One. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Scott Phillips.

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