How the race for Artificial Intelligence at Microsoft, Meta and beyond is progressing

5 November 20236 months ago babelfish

Have Artificial Intelligence stocks bit off more than they can chew? Analysis by Bo Fifer, Lead Portfolio Manager of TCW

In Aesop's classic fable, the hare, which starts quickly, loses the race to the tortoise, which moves slowly. Given the rapid departure of Artificial Intelligence stocks in 2023, with the dawn of the era of generative AI (gAI), it is fair to wonder whether this sector has bitten off more than it can chew. Almost nothing is consistently up, and it wouldn't be surprising if AI stocks took a break from their current run; that would be a normal and healthy pattern in any bull market.

Will the rest of the market catch up to AI stocks? It is useful to remember why Aesop's hare ultimately lost: because it fell asleep and, therefore, why it literally stopped moving. A similar argument applies in the world of technology: for companies in the sector it is essential to maintain a regular cadence of product improvements. The consequences, for those who don't, can be very serious.

The rush of Artificial Intelligence stocks in 2023

While AI stocks may slow down or even lose ground in the stock market in the short term, the companies aren't stopping moving. Infrastructure providers are constantly improving speed and cost, builders are constantly improving model accuracy and capabilities, and developers are devising new ways to innovate entire industries. In this version of the tale, the hare will beat the tortoise. OpenAI opened the world's eyes to the possibilities of generative AI when it released ChatGPT to the public in November 2022. It wasn't the first large language model, maybe not even the best, but it made the technology accessible to the masses with an easy-to-use user interface even for those new to technology. Almost overnight, the market began extrapolating winners and losers; that is, which sectors (not just individual companies) would benefit or be decimated by this new technology.

The first winners were infrastructure providers like NVIDIA, on whose GPU chips the majority of generative AI takes place. In the public markets, Microsoft, thanks to its investment in OpenAI, and Alphabet were first movers, while Meta Platforms and others followed suit. They are companies with a capitalization of over 1,000 billion dollars and to see them move on the stock market huge financial flows are needed. And these stocks have moved up and down by hundreds of billions of dollars, for short periods of time, in reaction to the advent of generative AI. For example, in just over a month in early 2023, from the time news emerged about Microsoft's proposed investment in OpenAI until the rumors were confirmed, the stock gained approximately $400 billion in revenue. market capitalization. To put this in perspective, at the end of last year only 11 companies in the S&P 500 index had a higher market capitalization. From the beginning of this year to its peak in late August, NVIDIA stock added nearly $1 trillion in market capitalization.

The point is that generative AI is critical. And the best proof that these companies are not sleeping hares is to look at NVIDIA's price-to-earnings (P/E) ratio. In February 2023 (peak of the generative AI buzz), it was hitting a P/E of over 70x and many thought it was uninvestable. In mid-September 2023, the multiple shrank to less than 40x, while the price exploded: the company did not stand still and was not caught off guard, but grew its business. This trend explains why the current euphoria can be distinguished from previous “bubbles” in tech.

The winners and the losers

The race is not only not over, but has just begun. Like the Hare, many AI stocks could use a breather. Unlike the hare, we expect this pause to be short. Comparing a basket of “AI winners” from 2023 to a basket of “smartphone winners” from 2009, to compare this run to a previous big tech run: In the first seven months of 2023, the AI basket essentially doubled . It is a performance almost identical to that of the smartphone basket in its first half of life. We don't know what the AI basket will do from here on out, but the smartphone basket gained another 175% or so over the next three years. And it wasn't a straight line. During this bull run, the basket had a peak-to-peak drawdown of more than 30% at one point en route to that 175% incremental gain.

Every now and then, a long-term secular trend emerges that can be ridden for multiple years. In many ways, we are still riding the wave of the Internet, as over-the-top video streaming, social media and mobile telephony change our viewing habits. The decade-old cloud computing wave may have just crested its first crest as companies streamlined cloud spending and consumed available capacity in the first half of 2023, but we expect it to strengthen again. Electric vehicles, mandated by the government in many countries, will completely replace internal combustion engines in the next 10 to 20 years. And AI will radically change the way we do business, whatever it may be. The stocks of the sector took off like a rocket, like the hare. Through September 27, NVIDIA has returned 191% year over year and is the clear leader among Artificial Intelligence stocks. The next 190% will certainly be harder to achieve and take longer, despite an accelerating and improving fundamental picture throughout the year.

The next leader will likely be another stock, although it's difficult to identify a company with a stronger tailwind right now. We divide the investable universe of AI stocks into three broad categories: providers of underlying technology (infrastructure), AI systems (the actual models), and AI adopters (companies that use AI to gain a competitive advantage). We expect the push to build AI systems will continue to fuel the first two types of companies in the short to medium term, but over time we expect widespread AI adoption to support the outperformance of the fund's stocks over the long term.

This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/innovazione/corsa-titoli-intelligenza-artificiale/ on Sun, 05 Nov 2023 06:15:57 +0000.