Because generative AI will not be a bubble for Amazon, Microsoft, Accenture and beyond
AI is a long-term investment theme, although some popular stocks may appear a bit overvalued in the short term. Comment by Rahul Ghosh, Portfolio Specialist Global Equity, T. Rowe Price
There are several compelling reasons to consider AI as a long-term investment theme, even if some popular stocks may appear a bit overvalued in the short term. In retrospect, 12 months ago we had an optimistic view for global technology in 2023. We continue to be positive for 2024 not only for AI, but also for the technology sector more generally. Many of the global technology stocks covered by our analysts are experiencing accelerating organic earnings growth and operating margin expansion, seemingly set to continue well into 2024. AI has been, and may still be, cyclical, but we believe its trajectory, characterized by an S-curve, was probably underestimated by the market.
The boom in generative AI
Generative AI relies heavily on semiconductors due to the high processing requirements. Considering the related opportunities, the first to benefit are, among others, companies involved in the advanced semiconductor chip ecosystem and semiconductor capital expenditure (the base of the pyramid), such as NVIDIA, TSMC, ASML, Lam Research. One of the best ways to take advantage of generative AI in this mega-trend has been to leverage the “picks and shovels” and other parts of the infrastructure layer.
The second level of the pyramid is represented by AI infrastructure providers (such as Amazon, Apple and Alibaba Cloud) and AI enablers (IT services companies, such as Accenture and Microsoft Azure). At the third level of the pyramid are large foundational language models, such as Open AI's GPT-4, or Meta's LLaMA. Finally, at the top of the pyramid, there are personalized AI applications, for which, at the moment, it is less clear who the final winners will be. While AI adoption is still in its infancy, it appears to be exceptionally rapid compared to previous IT booms, such as those involving PCs and smartphones, thanks, in part, to generative AI and large language models. They have encouraged companies, technological and otherwise, in many sectors and industries to experiment with early adoption, driven more by the possibility of gaining in terms of efficiency, rather than by the fear of being excluded.
Generative AI is not a bubble, but a truly innovative technological breakthrough. A cycle of business growth driven by AI is already underway. The maturity that computing innovation has achieved in the past, in terms of decentralized and superfast computing via the cloud, powerful smartphones and so on, has enabled the great leap forward in AI that we are now experiencing. AI requires a robust combination of computing power, experienced software and hardware engineers, large amounts of data, and a significant number of new customers. In the IT sector, this benefits companies active in existing large-scale internet platforms. All this means that AI, at least initially, is not a “disruptive” technology.
The opportunities in 2024
Globally, the outlook for the technology in 2024 appears quite strong, with continued growth in generative AI and a cyclical recovery in the broader semiconductor market, including PCs and smartphones. Of course, this favorable view on technology must be balanced against broader macroeconomic risks and concerns, such as a potential slowdown in US consumer demand, China's slow economic recovery and escalating geopolitical uncertainties. in the Middle East, Ukraine and other regions.
However, we believe the AI boom is likely to have sufficient momentum to continue into 2024, overcoming broader macroeconomic concerns, many of which are not new, but were indeed already present in 2023. We still see many compelling areas of opportunity for investors investors in global technology in 2024. The semiconductor complex could continue to be a source of strength. Demand for semiconductors is likely to remain strong, driven by accelerating demand for AI, as evidenced by AMD's latest assessment that the global accelerator chip market will be worth $400 billion by 2027. The company revised its market growth forecasts upwards.
Cloud computing and enterprise software are expected to continue to see growth, driven by growing demand for flexible and scalable IT solutions. The development of AI is destined to provide further impetus to this trend; therefore, we believe the data center spending outlook will remain strong as companies adapt their data for use with AI. As a result, companies will invest more in middle-office and back-office software, such as Workday, SAP and ServiceNow. Fintech areas may also show some strength, which is why we remain committed to the sector. E-commerce has continued to accelerate following the reflation following the pandemic, and fintech companies are more disciplined when it comes to operating expenses.
Risks on the horizon
With such strong momentum, we are aware of the risk of a potential bubble forming, resulting in excessive valuations for the most popular AI stocks. Potential opportunities and risks are currently linked more to broader macro concerns than to specific issues in the technology sector. On the economic front, while the Fed appears to be managing a decent glide path in the US, the risk of a slowdown remains, which, together with the current weakness of the Chinese economy, could curb global demand for technological products and services.
On the geopolitical front, although tensions between the US and China have recently eased, we must be aware of the possibility that they will flare up again, with potential impacts on IT demand and supply chains. Lastly, regulatory risk also remains a challenge for the sector. As governments seek to adapt to the more widespread adoption of AI and the wider availability of data, AI remains at risk of increased government regulations on data privacy, antitrust issues and national security , as well as potentially increased compliance burdens and costs for technology companies. However, we continue to believe that the AI theme is bigger than many investors perceive and that it can generate exponentially greater returns and capital expenditures than the market anticipates.
This is a machine translation from Italian language of a post published on Start Magazine at the URL https://www.startmag.it/innovazione/ia-generativa-prospettive/ on Sun, 21 Apr 2024 10:25:13 +0000.