Artificial Intelligence: A Driving Force in US Stock Markets
Introduction
Artificial intelligence (AI) has emerged as one of the most bullish sentiments in US stock markets this year. Despite concerns about inflation and the health of the financial sector, the stock prices of the seven largest technology companies by market capitalization have propelled the S&P 500 into a bull market.
This rise in the stock market has compelled even the busiest of bears to invest their money. Although prices have seen some decline in recent weeks, active fund managers still have a higher ownership of large tech stocks than at the beginning of the year.
With the growing interest in AI, Wall Street banks are starting to guide investors towards potential AI beneficiaries. For instance, Citi offers an AI “basket” that includes Adobe, a leading design software company. On the other hand, Bank of America provides an “AI Risk Index” which also features Adobe. This contrasting approach illustrates the challenges that investors face in a rapidly changing market.
The Rapidly Changing Outlook
The narrative surrounding AI is evolving at a rapid pace. Alphabet, Google’s parent company, is now considered a staple of AI investments, but until May, many observers believed it was falling behind its competitors in terms of AI innovation. However, the company’s annual developer conference earlier this year helped to change expectations, and Alphabet is now seen as a beneficiary of AI advancements.
Similarly, Adobe reassured investors about its AI projects, alleviating concerns that products like Photoshop might be threatened by new services. Companies must constantly work to stay on trend in the AI space, as the market holds both opportunities and challenges for them.
The Impact of AI on Business Models
AI is not just a passing trend; it already has tangible use cases that are impacting major companies financially. The extent of its impact may be debatable, but few doubt its potential. The late 1990s and early 2000s saw a similar frenzy around the internet, where the markets successfully identified emerging trends but struggled to accurately predict the pace or beneficiaries.
Of the top 10 companies in the US by market capitalization during the peak of the internet bubble, only Microsoft remains among the top companies in the S&P 500 today. This serves as a cautionary tale, warning investors that current dominant players might not necessarily retain their dominance in the future.
Cisco, for example, briefly became the world’s most valuable company based on the assumption that providing underlying infrastructure for internet companies would lead to exponential growth. While Cisco’s net income has grown over the years, the enthusiasm in 2000 was so extreme that its shares are still nearly a third below the peak of that year. On the other hand, companies like Amazon and Apple experienced significant growth during the same period.
This comparison provides reassurance for stock pickers, as it signifies the potential for a paradigm shift in favor of active investment strategies. However, navigating the AI landscape is no easy task and requires thorough research and expertise.
Unveiling the Opportunities
AI is a field that continues to intrigue investors with its vast potential. As the technology improves productivity, it becomes easier for new businesses to disrupt established patterns. This changing landscape raises questions about the viability of traditional business models and highlights the importance of staying up-to-date with the latest AI advancements.
To fully embrace the opportunities presented by AI, investors need to consider several factors:
- The degree to which AI can extrapolate long-term cash flows and earnings requires a shorter duration than before AI. This implies that traditional valuation methods may need to be adjusted to account for the rapidly changing AI landscape.
- The significance of niche markets in AI. While some companies may benefit significantly from AI, thriving in specific niches can be critical for sustained success, especially as the market becomes more crowded.
- The potential for AI to disrupt established businesses. As AI use cases continue to expand, traditional moats that once protected businesses may no longer be as effective. Therefore, investors must carefully consider the vulnerabilities of different business models.
As AI continues to shape industries, investors need to stay vigilant and explore new investment opportunities emerging in the field.
The Importance of Stock Pickers
The rise of AI has sparked discussions about the role of stock pickers in today’s market. Active investment strategies are experiencing renewed interest after years of passive fund dominance. While AI can provide valuable insights and analysis, it does not eliminate the importance of experienced stock pickers.
Successful stock picking requires a deep understanding of individual companies, their business models, and their potential for growth. AI tools can certainly assist in the process, but human intuition and expertise are still essential for making informed investment decisions.
Summary
AI has become a driving force in US stock markets this year, with the stock prices of major technology companies propelling the S&P 500 into a bull market. Despite concerns about inflation and the financial sector, active fund managers continue to invest in large tech stocks.
Wall Street banks are guiding investors towards potential AI beneficiaries, but the narrative around AI is constantly evolving. Alphabet, once considered to be falling behind in AI innovation, is now seen as a beneficiary. Similarly, Adobe has reassured investors about its AI projects.
Investors must navigate the rapidly changing AI landscape, considering factors such as the impact on business models and the risk of disruption. The experiences of the late 1990s and early 2000s internet boom serve as a reminder that current dominant players may not necessarily retain their positions in the future.
While AI presents significant opportunities, investors must carefully analyze the changing dynamics of traditional business models and consider the role of niche markets in AI. This shifting landscape highlights the need for in-depth research and expertise to fully embrace the potential of AI.
Stock pickers play a crucial role in today’s market, even as AI tools become more prevalent. Human intuition and expertise are essential for making informed investment decisions. As the world continues to embrace AI, stock pickers will remain valuable in identifying successful investment opportunities.
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Enthusiasm for the growth of artificial intelligence has been one of the few consistently positive sentiments in US stock markets this year. Sharp increases in shares of the seven largest technology companies by market capitalization 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 busy bears to take money off the sidelines and put it to work. Although prices have fallen in recent weeks, ownership of large tech stocks among active fund managers remains much higher than at the start of the year.
A myriad of Wall Street banks are trying to guide new converts to AI. Citi’s AI “basket,” for example, offers a narrow list of apparent AI beneficiaries such as Adobe, the design software company. Meanwhile, investors looking for short opportunities could check out Bank of America’s “AI Risk Index,” which features . . . Adobe, the design software company.
Maybe it would be better to find a long opportunity that both banks can agree on, like 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 like — you guessed it — Palantir.
The contrasting baskets highlight the challenges facing all investors. Opinions are changing rapidly. Google’s parent company Alphabet is now a staple of AI baskets and investment funds, but until May, many observers feared it was falling behind its rivals in terms of AI innovation after disappointing initial response to its chatbot. “Bard”.
The company’s annual developer conference earlier this year, where it launched a revamped search engine and provided more details on how it could make money by incorporating advertising into its AI-powered products, helped change the expectations, according to Céline Zhao, head of US equity research at trading firm Optiver.
“We’ve seen the narrative shift rapidly from potentially disrupted Alphabet to beneficiary,” he says. Similarly, Adobe reassured investors about its AI projects when they began to worry that products like Photoshop were under threat from new services like Midjourney.
This race to stay on trend is not going to slow down. If AI improves productivity as evangelists hope, it may become easier for new businesses to disrupt ingrained patterns.
“The degree to which investors can extrapolate long-term cash flows and earnings probably requires a shorter duration than before AI,” says Michael Grant, head of long/short strategies at Calamos. “It raises genuine questions about the ‘moats’ of many business models.”
AI isn’t just a fad—the extent of its impact is debatable, but few doubt it has at least a few real-life use cases that are already having a financial impact on major companies.
In this respect, the Internet bubble of the late 1990s and early 00s can be a good comparison. Back then, the markets did a decent job of spotting the direction of trends, but they weren’t so good at judging the pace or the precise beneficiaries.
Of the 10 companies that were the largest in the United States by market capitalization when the 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 that the dominant players today will be dominant 10 years from now, and that’s not always true,” warns Rob Arnott, president of asset manager Research Affiliates.
At the turn of the century, Cisco briefly became the world’s most valuable company, on the assumption that providing the underlying infrastructure for Internet companies would lead to rapid growth. Similar logic has driven Nvidia’s more than 200% increase this year: It might be hard to guess who will make the best use of AI, but whoever it is will likely be using Nvidia’s chips to do it.
The theory behind Cisco’s trade wasn’t necessarily wrong: Its net income has grown by double-digit percentages in most years since the tech bubble, and has increased by more than 500% overall. But the enthusiasm in 2000 was so extreme that its shares are still nearly a third below that year’s peak. Amazon gained about 3,600% in the same period. Apple is up more than 14,000%.
These comparisons could be reassuring for stressed stock pickers. A mutual fund manager points to AI as a key part of a larger “paradigm shift” in favor of active strategies after a decade or more of tailwind behind passive funds.
Taking advantage of this opportunity, however, is easier said than done.
“The narrative that this is good or bad for stock pickers. . . it can be a little dangerous,” says Arnott. “It will be good for Well stock collectors. It will be brutal for those who are not.
nicholas.megaw@ft.com
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