A year ago, when the path of rising interest rates was in full swing and inflation seemed out of control, one of the most popular prophecies among market commentators was the end of the golden age of tech stocks.
With the era of ultra-cheap liquidity, it was said, the mega-valuations of growth companies would also come to an end, including big American giants like Apple and Alphabet. The astonishing multiples, it was thought, would no longer be justified, and the promise to continue generating growth would become more difficult to maintain.
To the surprise of many, today we find ourselves facing a new boom in the Nasdaq, an index that in recent years has reached a level of gravitational attraction capable of carrying the fortunes of all global equity investors on its own.
But who unleashed the bull? Ask ChatGPT. The frenzy sparked by the popularisation of generative artificial intelligence has reminded us that we are on the brink of a new industrial revolution. Forget about malfunctioning prototypes, customer support chatbots that misunderstand things. Just a few months ago, you would have read in any report that the AI revolution would be slow to arrive or that automation would only affect the most repetitive tasks.
Try asking yourself the same question today. It seems that investors have woken up on a station bench, with the last call of the train heading towards the future in their ears, and they are rushing towards the first carriage they find in front of them, hoping it’s the right one.
Valuations to be made on Nvidia
The company symbolic of this strange phase is Nvidia, the latest addition to the club of mega-corporations with a market capitalisation of over a trillion dollars. The company manufactures microchips and until a few years ago was known to most for the graphics cards installed in many computers. These hardware components are necessary for the supercomputers that support artificial intelligence-related technologies.
The company had already seen the price of its shares soar in recent years (also during the cryptocurrency boom), and according to many analysts, it was the symbol of the overvalued market that characterised the technology sector. However, after the upward revision of revenue expectations in the third quarter to $11 billion (+64% on last year’s record numbers), the market capitalisation exploded, making it the sixth largest publicly traded company in the world by value.
The spark that triggered the euphoria was the realisation that the era of artificial intelligence has already begun. The launch of the new version of ChatGPT by OpenAI Inc. has opened the eyes of ordinary people and investors.
Artificial intelligence has been talked about for many years. According to the report “AI in action: where is the smart money going?” published in May by Deutsche Bank, there have been over 175 thousand AI patent applications published between 2012 and 2022 among the 193 members of the World Intellectual Property Organization. But it seems that the industry has reached a boiling point. This has been mainly made possible by the increase in computing power, which has normalised the use of technologies on a large scale.
Nvidia shareholders are not the only ones who have benefited from this situation. Research and investments in artificial intelligence have multiplied for years under the surface, and many large companies today are trying to position themselves as winners in the race for artificial intelligence in the eyes of investors. A prominent example is Alphabet Inc., the parent company of Google, which has engaged in a massive communication campaign to publicise the numerous applications of AI within its services and, as a result, has outperformed the market even without clear evidence of positive earnings impact.
A flash in the pan?
The markets’ surge has caught many by surprise and can be interpreted in various ways. The positive interpretation, from which investors can learn a lesson, is that technological innovation is a factor of positive surprise in the market and can be so decisive as to overturn even fundamental valuations. This is significant evidence, especially in the current times.
Of course, the frenzy around AI has also raised some eyebrows, and many wonder how solid the foundation of this rally is, with comparisons being made to the dot-com bubble.
Is AI here to stay?
The questions we need to ask ourselves, therefore, are: Will the trend of artificial intelligence and innovation continue to positively impact the markets? Which companies will be the winners? And what is the best way for investors to take advantage of it? If we look at various studies, which should be approached with caution, just like long-term analyses, the numbers will surely be tempting.
According to the report “The economic potential of generative AI: The next productivity frontier” published in June by McKinsey & Company, generative artificial intelligence, the technology behind ChatGPT itself, will be the foundation of a new productivity revolution. The study considered 63 use cases of generative artificial intelligence, from customer service to corporate marketing. According to analysts, the increase in productivity can create a value between 2.6 and 4.4 trillion dollars annually (even more than Italy’s GDP, even according to the most conservative projections).
According to the market analysis published by Precedence Research, which observes trends from 2022 to 2032, the turnover of the artificial intelligence sector will grow by 19% annually until 2032. A more optimistic report was published by Fortune Insight in May: “Artificial Intelligence Market Size to Surpass USD 2,025.12 billion by 2030, exhibiting a CAGR of 21.6%,” where it hypothesises an annual growth rate of even 21.6% until 2030. In short, from any angle, it seems that artificial intelligence is destined to generate a level of growth that would be tempting to any investor.
Of course, there are also risks and potential negative effects that such a revolution could unleash on the global economy and the job market. How many people will lose their jobs? Will the workforce be able to retrain? Will there be a deflationary effect? And who will foot the bill? All these questions will eventually need legislative answers. The impacts of artificial intelligence are currently a subject for futurists, but they could soon become a topic for lawmakers.
While waiting to find out what will happen, we can take for granted that artificial intelligence will continue to dominate the world of work from now on. Less clear is the list of companies that will benefit from this revolution. The history of major industrial revolutions is filled with companies that rise, expand, burst, and are forgotten. In short, we may see many meteors explode before discovering the Google and Amazon of the fourth industrial revolution (if there will be any). This is not a minor risk in a market where valuations, measured, for example, by the price-to-earnings ratio, of some companies specialised in the sector reach exorbitant figures with ratios above 30/40x, against an industry tech average around 25x.
As we mentioned, for now, a large portion of the pie is still in the hands of large-cap companies. Microsoft is being rewarded by investors for being the first company to invest in OpenAI, the company that programmed ChatGPT, and has invested $13 billion in it since 2019. The company has stated that for every percentage point of market share it gains in the search engine sector, it will have an opportunity for $2 billion in annual advertising revenues. Alphabet, the parent company of Google, has launched its own version of ChatGPT called Bard, in an attempt to enhance the capabilities of its search engine. And it’s recent news that Meta will collaborate with Microsoft for the development of Llama2, its own artificial intelligence model to be used for research and commercial use.
In addition to the Big Tech companies, other evident beneficiaries are the companies that manage the infrastructure to make the system work (semiconductors, software, internet companies), the entire technology and innovation sector that Moneyfarm also covers with a selection of thematic ETFs.
In any case, given the risks and the complexity of knowing the winners with certainty, we continue to recommend a diversified and selective approach. The wave of AI has just arrived, and the game, as often happens in investments, will be won in the long term. As frequently demonstrated by the past, playing the game intelligently seems to be the smartest thing to do.
Giorgio Broggi: Giorgio joined Moneyfarm as a Quantitative Analyst in December 2021 and he is a member of the Investment Committee. Prior to joining the company, he worked at Barclays Wealth Management and S&P Market Intelligence, gaining expertise in Funds Research and ESG Investing. Before starting his professional life, he successfully completed a double-degree at Eada and EDHEC Business School, obtaining two Masters in Finance and specialising in factor investing and portfolio construction. He is a CFA charterholder.
*As with all investing, financial instruments involve inherent risks, including loss of capital, market fluctuations and liquidity risk. Past performance is no guarantee of future results. It is important to consider your risk tolerance and investment objectives before proceeding.
