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Don’t put all your eggs in the AI basket, market specialists warn

By Jessica Penny
5 minute read

While winners of the tech rally have posted considerable earnings growth this reporting season, market specialists are warning investors not to wholly trust in the AI thematic.

Nvidia’s market capitalisation surpassed US$2 trillion for the first time last Friday, just nine months after it attained the US$1 trillion market capitalisation in June last year.

Nvidia’s stock surge began with gains of 239 per cent in 2023 and continued this year with year-to-date gains of some 66.1 per cent.

The chip maker’s milestone market capitalisation growth came after it reported earnings growth of 22 per cent on the quarter and 265 per cent on the year to US$22.1 billion, which was warmly welcomed by a number of Australian fund managers with strategic holdings in the firm.

Nvidia’s founder and chief executive, Jensen Huang, attributed the monumental growth to surging global demand for accelerated computing and generative AI.

Speaking at a Stanford University forum last week, he remarked that AI could pass the human test as soon as five years from now.

“If I gave an AI ... every single test that you can possibly imagine, you make that list of tests and put it in front of the computer science industry, and I’m guessing in five years’ time, we’ll do well on every single one,” said Huang.

The rise of AI

Following a period where technology stocks flourished as a result of zero per cent interest rates and stimulative monetary policy in the wake of COVID-19, the market crashed when interest rates began to lift in 2022. However, the upside surprise when economic conditions proved more favourable than predicted and the transformative changes that it’s believed the AI revolution will usher in, have lit the spark for a rapid reversal in the market’s fortunes.

In a note last week, Zenith Investment Partners explained that the rising appeal of AI is linked to investors’ expectations that it will lead to productivity gains and, as such, to incremental revenue uplifts where companies can monetise their existing customer base.

For example, Zenith’s largest international shares holding, Microsoft, plans to generate revenue by charging an additional fee to users who utilise their “co-pilot” product, which is an AI feature that integrates into Word, Excel, PowerPoint, Outlook, and Teams.

But, while it’s clear that the AI wave – and its increasing causal demand – is showing no signs of slowing, Zenith Investment Partners’ Calvin Richardson warned portfolio managers against relying solely on specific stocks.

“Portfolios should maintain a healthy AI allocation without relying solely on specific stocks,” Richardson said.

Zenith’s portfolios, he noted, have retained a robust allocation to the AI thematic through its technology exposures, yet without relying on a concentrated bet on these tailwinds.

“In addition to Microsoft, our second-largest international holding, Alphabet, is likewise aggressively competing in the AI arms race,” he said.

“Most recently, this has been through their newly launched generative AI model capable of ingesting video, audio and text to rival Microsoft’s investment in ChatGPT.”

Apple also features prominently in Zenith’s portfolios and is similarly investing heavily in AI.

Richardson conceded that the stretched valuations of these mega caps – those colloquially coined “magnificent seven” group of AI-centric stocks – have gathered considerable attention following their rapid ascent this past year.

“Whilst we’re sympathetic to these concerns, as long-term capital allocators, it’s critical for us to partner with fund managers who thoroughly understand the immediate and longer-term risks and opportunities presented by innovative technologies, such as AI,” Richardson said.

Looking underneath the hood of the AI wave

Similarly, ECP Asset Management’s Annabelle Miller advised investors not to get carried away with the “market euphoria” and suggested they should instead turn their attention to leading industry supplies.

“Now is the time to focus on high-quality companies with strong fundamentals that are positioned to benefit from the huge growth in long-term demand for semiconductors,” Miller said.

Companies such as Advantest and Dutch company ASM International, she noted, are growing their earnings as key suppliers to semiconductor manufacturers such as Nvidia and AMD and are benefiting from both the surging demand in AI products and advanced computer chips, more broadly.

Namely, ASM International shares have gained around 1,000 per cent in five years, while Advantest has gained some 650 per cent over the same period, with both companies outperforming all of the magnificent seven companies other than Nvidia.

“While our expectations for future returns have come down somewhat, we still view these companies as extremely high-quality businesses with a long runway of growth ahead of them,” Miller said.

“Both AMSI and Advantest may be better positioned to withstand market volatility. Neither carry the same degree of technological risk or product failure as Nvidia or AMD, but both benefit from the rising global spending on semiconductors,” she concluded.

According to Miller, ASMI and Advantest are the “picks and shovels” of the semiconductor industry, which continues to advance Moore’s Law. This is the observation that the number of transistors on a computer chip will double every two years with a minimal rise in cost, rapidly reducing the cost of computers.

“By focusing on high-quality businesses such ASMI and Advantest, investors can gain exposure to the structural growth tailwinds of the semiconductor sector without the same degree of technological risk or product failure.

“These companies are likely to keep generating large amounts of cash that can be reinvested back into their businesses. They are well positioned to ride out the volatility of stock markets and remain resilient in the face of both known and unknown challenges.”