Schroders believes that artificial intelligence (AI) is “going to do a lot of wonderful stuff” as the technology continues to develop, though it has advocated a more nuanced approach to selecting these stocks.
Last month, chipmaker Nvidia announced quarterly earnings of US$22.1 billion, growing 22 per cent for the fourth quarter ended January 2024. Earnings were up 265 per cent from a year ago, with Nvidia’s founder and chief executive, Jensen Huang, attributing the monumental growth to surging global demand, which has propelled generative AI and accelerated computing to “the tipping point”.
Meanwhile, Google’s parent company, Alphabet, posted $86.3 billion in fourth-quarter sales, up 13 per cent year-on-year, as it flagged its “Gemini era” and Microsoft, which holds investment in OpenAI, saw revenue rise 18 per cent to $62.0 billion.
On the day of Nvidia’s results announcement, the S&P 500 saw its largest daily gain in 13 months and the Nasdaq Composite finished just shy of a record high.
According to Martin Conlon, head of Australian equities at Schroders Australia, caution is necessary around some of these high-valuations in the face of market enthusiasm.
“I still believe ‘that it’s different this time’ are some of the most dangerous words in investment and the reality of market valuation levels, particularly in the US market, are high by historical standards and they are very high relative to interest rates,” Conlon said.
He observed that, with the US market representing almost 70 per cent of the global market cap – with approximately 30 to 40 per cent of that market in tech and communications – but only 18 per cent of global GDP, it signals overexposures for all international investors.
“There is a big presumption there that the profit growth of particularly those big technology companies is going to keep on growing, and it’s going to be durable forever,” he elaborated.
“And when the companies underlying that position are, for the most part, global monopolies, I think that can be a sign of complacency. Those numbers and valuations give me a lot of pause for thought.”
Still, the investment executive did not discount the potential of AI, citing it is “going to do a lot of wonderful stuff” and was worthy of investments.
“But I think, as I alluded to earlier, the profit projections of where, and how it’s going to change the profit pools of the world, are probably running ahead of what is most likely to happen,” he said.
Schroders’ Sebastian Mullins, head of multi-asset, also warned against ignoring the leading tech giants just on AI valuation concerns.
“Earnings in these stocks have continued to beat expectations because their current business models have been delivering, very little AI earnings can be attributed to current results,” he said, observing they have doubled the margins and have grown free cash flow twice as fast as the other 493 stocks in the S&P 500.
“While it’s likely these stocks pull back after a strong rally, it’s premature to call them a bubble,” Mullins conceded.
Last month, Fidelity International addressed whether the AI rally is demonstrating signs of a nascent bubble, noting parallels between the meteoric rise of Nvidia against that of Cisco in the late ’90s.
However, the investment manager believes it is not yet time for investors to worry, although similarities might exist.
Tom Stevenson, investment director at Fidelity, posited that, if an AI bubble does exist, it remains in its early stages.
“The valuation premium is well short of the level reached in 1999 or even in the early 1970s when the most popular shares were priced nearly twice as expensive as the rest of the pack,” he said.
“We are a long way off that today. Sentiment is not yet universally positive. When it becomes so, it will be time to worry. We’re not there yet.”
