“A billion here, a billion there, and pretty soon you’re talking about real money.”
Attributed to Everett Dirksen
In earnest, it all started in November 2022 when ChatGPT, developed by Open AI, bolted out of the gates and into the collective consciousness. A company whose mission is “to ensure that artificial general intelligence benefits all of humanity” sparked an arms race in capital spending between leading technology companies.
Thanks to the promise and emerging reality of artificial intelligence, vast sums of money have been deployed globally in the proliferation of data centres and supporting infrastructure that allows these power and computational intense models to run. These sums are staggering and amount to something north of US$100 billion a quarter by US companies alone.
Since the launch of ChatGPT, with the exception of Tesla the so-called ‘Magnificent 7’ tech stocks (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) all saw their share prices soar as investors poured money into them and the technology sector in general. So significant was the scale of this investment it drove US share markets higher, with the S&P 500 rising almost 39% to the end of July. These seven companies are huge, with a combined market capitalisation of well over U$15 trillion, or approximately 50x the market capitalisation of the New Zealand equity market.
Such excitement and collective price appreciation does not occur very often, but this is the modern industrial revolution whose influence will be felt for generations to come. Can the heady returns continue, or has the easy money been made?
With the economic story having been punctuated with the pandemic and low interest rates in 2020, followed by high inflation, slowing economic growth, and peaking interest rates in 2024, there has really only been one game in town – technology – and a narrow market, with approximately only 25% of the S&P 500 outperforming. And this eclipses the broader market, with mid and small capitalised indices lagging its bigger brother.
But this changed in July, as concerns over the sustainability of AI investment began to creep in. For all of the billions of dollars poured into the ‘arms race,’ the output, in the form of revenue, remains somewhat elusive, and the tone of conversation by Alphabet (Google) suggested the identification of the ‘killer’ application and use-case for AI was a little opaque and distant.
Now all eyes are on central banks and when interest rates will finally start to decline. With the opaqueness of AI-related revenue heightening and the prospect of lower interest rates helping the broader economy – especially those companies with significant amounts of debt – will this cause a pervasive rotation into other investments? Perhaps.
Early (albeit short) evidence suggests that there is life in the smaller end of town, with some catchup in this noble sector globally evident during July. Here in New Zealand, too, the expectation of lower interest rates and cheaper valuations has seen ‘takeover’ interest increase. To be sure, ‘a swallow does not a summer make,’ but it is reasonable to think that other investments can begin to look attractive as certainty over balance sheets and business optimism improves. This would lift all boats as outsized profits find a new home.
This does not mean it is the end for AI-related investments – far from it; it does not take a huge flow from one big bucket into one smaller to cause it to overflow.
What we are seeing now is a broadening of the investment climate. Investors and fund managers are asking themselves, Do I still want to be all over tech? I may not want to be outside it altogether, but do I still want to be pouring more and more money into the same companies that have done very well?
To return to AI – estimates vary, but somewhere between $600 billion and $800 billion has so far been spent on the AI ecosystem, most of it by the gigantic players, to open or strengthen or cement their respective positions. But, as mentioned, so far at least, there is little revenue to show for it, with some believing there is a revenue hole of $600 billion or more. Perhaps this does not matter in the short run; after all, the infrastructure will be relatively long-lived, and doesn’t everyone need a spare data centre or two?!
The significant capex and revenue shortfall is reminiscent of the telecommunications bubble of the 1990s, when ‘plant in ground’ in the form of fibreoptic cables were laid to service the expected internet boom. That came but it was late, leading to thousands of kilometres of ‘unlit’ fibre and company failures from enormous debt burdens. The key difference here is the companies investing today have a lot of money and little debt – they can continue to invest regardless – but there will be a lot of start-up failures along the way. We will learn a lot.
One company that has come under fire is Apple and its lack of an ‘own name’ AI model, but frankly, who knows what is going on inside those secret Cupertino labs! The soon-to-be-released iPhone 16 will sport Apple Intelligence and an AI capability that will augment numerous capabilities and in time have seamless integration to language models.
ChatGPT is the frontrunner, but time will tell if that remains the case. Even Microsoft, which is ‘all in’ here, is barely mentioning OpenAI. This is an important iPhone release for Apple. The annual refresh cycle has grown stale but the company has stated that Apple Intelligence will only be available to iPhone 15 users and above. Should an upgrade frenzy ensue, we may witness the world’s first US$4 trillion market cap company.
This might become a reality, with the long-term winners of technology being those that utilise the improvements to drive productivity. This requires devices, which Apple has in spades, and the ubiquitous iPhone may once again become the standard bearer that it was in 2007.
Away from Apple and back to industry: perhaps some of what has been spent will be written off because companies are too early and there is no pervasive business model in the deployment of AI – or a gamechanger will come out of nowhere tomorrow, as ChatGPT did, and now there are hundreds of thousands of business models built on this facet of AI.
My final thought is that investors should keep their eye on the potential risk posed by a single company in this fierce arms race. Nvidia’s share price has dropped 50% on 14 separate occasions since its IPO in 1999, which is reminiscent in a few respects of the volatility and somewhat unrealised promise of the late 1990s tech boom.
But I’m certain that if I were a fly on the wall in a different Magnificent 7 boardroom I would hear the directors debating how to solve and monetise their AI spend. While it may not be clear what or how right now, they will be laser-focused on leading the arms race, and that may include the purchase of another 20,000 chips for $500 million.
Nvidia has done some very smart things, and made a good number of people wealthy, but nobody, especially Meta, wants to be held hostage to a single supplier. The competition is restless, they are coming, and the dollars will not find their way into one pocket. The rate of growth is going to slow dramatically, and at some point there will be an industry reset. The real value for investors lies in deciding where and when that “some point” is.
Tim Chesterfield is the long-time CIO of the Perpetual Guardian Group and the founding CIO and Director of its investment management business, PG Investments. With $2.6 billion in funds under management and $8 billion in total assets under management, Perpetual Guardian Group is a leading financial services provider to New Zealanders.
Perpetual Guardian Group recently acquired boutique fund manager Castle Point, which now forms part of the Group’s investment management suite of businesses.
by Tim Chesterfield, Chief Investment Officer, PG Investments
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Information provided in this publication is not personalised and does not take into account the particular financial situation, needs or goals of any person. Professional investment advice should be taken before making an investment. The information provided in this article is not a recommendation to buy, sell, or hold any of the companies mentioned. PG Investments is not responsible for, and expressly disclaims all liability for, damages of any kind arising out of use, reference to, or reliance on any information contained within this article, and no guarantee is given that the information provided in this article is correct, complete, and up to date.
This article was originally published by the NBR. You can read the original piece here.
