Market Views: Will artificial intelligence make real profits for tech?
There's no denying it: artificial intelligence (AI) has become red-hot, driven largely by the sudden surge in popularity of OpenAI's Chat GPT, an AI-powered language model that is capable of generating human-like text.
It has opened up a whole new world of possibilities and investors have latched on to that tantalising prospect.
Companies specialising in AI hardware, such as Nvidia and AMD, have experienced a surge in revenues, as have cloud infrastructure providers like Microsoft, Google, and Amazon Web Services, who are also witnessing increased AI-related usage.
Nvidia’s stock soared to a new all-time high after the company announced a series of partnerships with Google Cloud recently.
Will the current rally extend to the rest of year? Will AI keep being touted as the hot investment idea to reel in higher profit and revenues for tech companies?
AsianInvestor asked investment professionals how much more tech stocks can climb this year and what other 'big ideas' could explode on to the scene. We also asked them about the potential challenges and disruptive factors institutional investors should look out for.
The following responses have been edited for clarity and brevity.
Ben Kirby, co-head of investments and managing director
Thornburg Investment Management
In the immediate wake of a blowout earnings report, chipmaker Nvidia’s flat performance demonstrates buyer exhaustion.
Although the stock is up over 200% in 2023, it carries a price-to-earnings ratio over 100x.
On the other hand, Taiwan Semiconductor Manufacturing Company, the territory’s leading semiconductor manufacturer, is trading at just over 15x earnings.
It is one of the best businesses in the world as it is critical to the global supply chain. TSMC has a wide moat around the business that grows with each new component, and they pay dividends over time.
We favour it as a long-term holding, and believe any potential geopolitical challenges are already priced in.
Aside from the technology sector, multinational telecommunications and energy companies remain attractive. Broadly speaking, we believe returns will be competitive over time with much lower volatility.
The two stock sectors are rooted in the idea that those businesses can generate cash flow in the future and with their pricing power, grow them over time.
Paul Nestro, MD and fundamental growth and core equity research director
State Street Global Advisors
This is an exciting time for change and innovation.
The convergence of several technological advancements is ushering in the age of generative AI, which has the potential to impact nearly every industry and business.
Against the backdrop of sharply higher valuations for some high-profile companies, some investors have questioned whether they are too late to get aboard the investment opportunity.
As ever, the story is much more than just the headlines. We are still at the early stages of AI.
Increasingly, it is critical to understand the global competitive dynamics and disruptive forces at work.
Scientific breakthroughs, driving productivity enhancements, leveraging the scale inherent with a platform or network effect, are some of the ways we identify opportunities while avoiding companies that are being disrupted or are at risk of disruption.
We see opportunities in healthcare where AI will likely revolutionise the treatment of cancer and other diseases, while increasingly providing customised treatments for patients and ultimately improving outcomes.
Energy efficiency and electrification are other areas that we estimate have long runways for growth. Today’s winners may be less obvious and will often include the enablers to these secular trends.
Jonathan Curtis, portfolio manager of Franklin Technology Fund
Franklin Templeton
We expect several industries within the tech sector, particularly within the enterprise buying center, to experience a reacceleration of growth heading into 2024.
This, in combination with a stabilisation of interest rates, should be a positive for tech stocks across all regions.
We also believe generative AI represents a meaningful computing platform shift, akin to the internet, mobile computing and cloud computing.
While we’re currently in the “build” stage of AI, which benefits semiconductor companies like Nvidia and others, we expect we’ll transition into the “application” stage of AI in the next 12-24 months, during which other industries like software and the internet will have opportunities to monetise new AI services that drive productivity gains.
Historically, these large platform shifts have driven strong performance for technology stocks over multiple years, so we think the AI trend is far from over.
Investors in the sector should consider that there may be near-term bumps in the road as generative AI scales and matures.
As is the case with any technology that requires significant investment upfront, the pace of adoption can sometimes lag the pace of investment, which can lead to stock price volatility and potentially buying opportunities.
Tejas Dessai, research analyst
Global X ETFs
It's worth noting that the influence of AI has thus far been quite narrow, but we expect this to diversify by year-end, extending benefits to smaller software firms, semiconductor companies, and cybersecurity providers as they integrate generative AI into their operations.
We’re also seeing tech-related capital expenditure spike up in the most recent quarters, which could drive revenues and profitability for other participants in the AI value chain.
We think the impact of the AI wave is going to be quite broad and investors need to look at the complete value chain to gain some exposure.
While we’re extremely bullish on the outlook for individual names like Nvidia, Google, Microsoft, Amazon, and other big tech names, we think investors should be looking at a more passive approach at this point given how early we are in this development cycle.
Beyond the immediate AI landscape, we believe that various technology sectors and sub-sectors stand to gain from increased AI adoption.
For instance, AI could significantly enhance cybersecurity efforts by improving the detection and resolution of attacks.
Likewise, sectors like e-commerce and digital media could realise substantial cost efficiencies through AI-generated content for product listings, advertisements, and more.
George Saffaye, global investment strategist
Newton Investment Management, BNY Mellon IM
Technology stocks enjoyed a strong run so far 2023, recovering from the meaningful pullback in 2022.
However, year-to-date (YTD) performance has not been as broad-based as many think.
To understand this, the S&P 500 is up almost 16.8% YTD through August 28th.
However, the magnificent seven – Meta, Apple, NVIDIA, Microsoft, Amazon, Tesla and Alphabet – account for almost 27% of the S&P 500 weight and are responsible for a return of almost 59% as a group.
The remainder of the S&P 500 is up almost 6% in aggregate.
There are a significant number of companies that have not participated in the rally, with some very attractive fundamentals.
As for the remainder of 2023, investors will likely focus on companies enabling AI. However, the ones who are investing now are not likely to see benefits for some time.
We think the markets are trying to recognise that difference.
The challenges and disruptive factors for the remainder of 2023 centre around the interest rate outlook, geo-politics, the global economy, especially China – and regulation.
Given the narrowness of the market thus far, sectors such as energy, healthcare and industrials offer attractive opportunities that could grow if the market broadens out.
abrdn
Whilst we are still waiting to see how quickly the end market demand will recover given cautious consumer environment, we believe the outlook for Asian technology stocks looks attractive into the next year.
The semiconductor industry is poised for a cyclical recovery in the short term whilst longer term, demand potential has only strengthened on the back of structural growth from generative AI, which may mean a multi-year demand boost for data centre content and infrastructure upgrade which is positive for the advanced semiconductor sector.
For instance, TSMC benefits from its chipmaking edge with 60% market share of the global foundry market, which positions it well to capitalise on the growing demand for high-end computing semiconductors that are used in AI applications.
Elsewhere, we see demand opportunity growing for HBM (high bandwidth memory) too, driven by increasing AI model size using more parameters and more data, as well as growing usage of multi-modal AI, which recognises context by processing multiple types of data – which will benefit me-mory makers like Samsung Electronics.
Richard Clode, portfolio manager global technology
Janus Henderson
The tech sector will continue to benefit into 2024 and beyond from the broader build-out of AI infrastructure as spend pivots to inferencing and the scaling out of new generative AI products and services.
We will then see the benefits accruing to AI platforms and then the software offerings that are able to monetise gen AI products that genuinely deliver on their promises of productivity gains.
Most of these apps and software offerings are still in beta or pilot so we believe there will be the opportunity for technology companies to deliver unexpected earnings growth into 2024 and beyond.
Given the run-up in AI-related stocks YTD, the key will be these companies’ ability to deliver that unexpected earnings growth to justify the higher valuations.
While the inflection in AI spending has been funded this year from borrowing from broader cloud budgets, that is unsustainable given ongoing cloud or data traffic growth.
We see a return to traditional cloud capex growth next year, which combined with ongoing growth in AI spending will lead to higher capex benefitting a broader range of infrastructure plays who suffered this year from that reduction in cloud spending.
Dominic Rizzo, portfolio manager of the global technology equity strategy
T. Rowe Price
The launch of ChatGPT ushered in a new wave of enthusiasm for generative AI, which has become the dominant theme for investors in 2023.
Generative AI is incredibly semiconductor-intensive, due to its immense parallel processing requirements.
As a result, AMD estimates that the AI chip total addressable market will meaningfully expand from $30 billion in 2023 to $150 billlion by 2027, a 50% compounded annual growth rate.
The best way so far to invest in this mega-trend has been via the linchpin digital semiconductor companies, like NVDA and AMD, innovating in this new secular growth market.
However, the AI theme will expand beyond just chips and impact companies across the entire technology landscape
While we are cognisant of mini-bubbles potentially forming, our job is to navigate this rapidly changing environment responsibly, via our investment framework.
In the near term, most stocks in the technology universe have accelerating organic revenue growth and operating margin expansion through H2 2023 and into H1 2024.
Moreover, though more expensive then at the beginning of 2023, the global technology universe is well below its historical peak valuations.
This all points us to a positive outlook for the technology sector from here.
Technology stocks have experienced diverging performance in 2023 with AI-related stocks outperforming strongly after the surge in the use of generative-AI made popular by applications like Chat-GPT.
However, non-AI related technology stocks such as those related to smartphones, PC, consumer electronics and autos have been facing an uphill battle mainly due to sluggish end-demand.
We believe increasing demand of higher computing power to power generative-AI applications would continue to be structural, disrupting how we undergo our lives and work.
But the market has built substantial expectations into share prices of related stocks along the value-chain, as reflected by rerated valuations.
The challenge remains with the cost and supply of high-powered computing chips and related computing infrastructure that are required to power these AI-models, and which applications would become profitable and can come out on top. We are still early in this trend to have a definitive answer.
With the broader technology sector having experienced an extended downturn cycle, there is an opportunity to narrow the underperformances against the AI-related group of tech stocks in the short-term.
Inventory levels in DRAMs, smartphones and other tech components are back to healthier levels and valuations are at attractive levels.