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Enthusiasm surrounding the growth of artificial intelligence has been one of the only consistently positive views in US stock markets this year. Sharp rises in the shares of the seven largest tech companies by market capitalisation have dragged the S&P 500 into a bull market, despite concerns about inflation and the health of the financial sector.
The surge has forced committed bears to take cash off the sidelines and put it to work. Though prices have fallen back in the past few weeks, ownership of big tech stocks among active fund managers remains far higher than at the start of the year.
A host of Wall Street banks are trying to guide newfound AI converts. Citi’s AI “basket”, for example, offers a one-stop shortlist of apparent AI beneficiaries such as Adobe, the design software company. Meanwhile, investors looking for short opportunities could consult Bank of America’s “AI Risk Index”, which features . . . Adobe, the design software company.
Maybe it would be better to find a long opportunity both banks can agree on, such as the data analytics group, Palantir? But if you then turn to the Royal Bank of Canada for a list of companies whose business models are under threat, it suggests groups such as — you guessed it — Palantir.
The contrasting baskets highlight the challenges facing all investors. Opinions are changing quickly. Google parent Alphabet is now a staple of AI baskets and investment funds, but as recently as May, many observers feared it was falling behind its rivals in terms of AI innovation, after the underwhelming initial response to its “Bard” chatbot.
The company’s annual developer conference earlier this year — where it launched a revamped search engine and gave more details on how it could make money by incorporating adverts into its AI-powered products — helped alter expectations, according to Céline Zhao, head of US equity research at trading firm Optiver.
“We saw the narrative quickly change from Alphabet potentially being disrupted to being a beneficiary,” she says. Adobe similarly reassured investors about its own AI projects when they began to worry that products such as Photoshop were under threat from new services such as Midjourney.
This race to stay on trend is not likely to slow down. If AI improves productivity as evangelists hope, it could become easier for new businesses to disrupt entrenched models.
“The degree to which investors can extrapolate long-term cash flows and earnings probably requires a shorter duration than it did pre-AI,” says Michael Grant, head of long/short strategies at Calamos. “It raises genuine questions around the ‘moats’ of many business models.”
AI is not just a fad — the extent of its impact is debatable but few doubt that it has at least some real-use cases which are already having a financial impact on major companies.
In that respect, the internet bubble of the late ’90s and early ’00s may be a good comparison. Back then, markets did a decent job of spotting the direction of trends, but were not so good at judging the pace or the precise beneficiaries.
Of the 10 companies that were the largest in the US by market capitalisation when markets peaked in early 2000, only one — Microsoft — is among the top companies in the S&P 500 today.
“When you have a huge new market, the presumption is the dominant players today will be dominant in 10 years, and that is not always true,” cautions Rob Arnott, chair of asset manager Research Affiliates.
At the beginning of the century, Cisco briefly became the world’s most valuable company, based on the assumption that providing the underlying infrastructure for internet companies would lead to rapid growth. A similar logic has driven this year’s more than 200 per cent increase in Nvidia — it may be hard to guess who will make the best use of AI, but whoever it is will probably use Nvidia’s chips to do so.
The theory behind the Cisco trade wasn’t necessarily wrong — its net income has grown by a double-digit percentage in most years since the tech bubble and is up more than 500 per cent overall. But the hype in 2000 was so extreme that its shares are still almost a third below that year’s peak. Amazon has gained about 3,600 per cent over the same period. Apple is up more than 14,000 per cent.
Those comparisons could be reassuring for stressed stock pickers. One mutual fund manager points to AI as a key part of a broader “paradigm shift” in favour of active strategies after a decade or more of tailwinds behind passive funds.
Harnessing that opportunity, though, is easier said than done.
“The narrative that this is good or bad for stock pickers . . . can be a little dangerous,” says Arnott. “It will be good for good stock pickers. It will be brutal for those who aren’t.”