- Two 'pick and shovel' companies
- Further opportunities in the AI eco-system
The rise of artificial intelligence (AI) kept the S&P 500 moving upwards last year despite rising interest rates, increasing global conflicts and concerns about the decoupling of the two largest economies. So far these returns have been concentrated in the hands of a few companies, but for the S&P 500 to keep rising into 2024 the technology will have to start showing meaningful boosts to productivity across multiple sectors. There are many Wall Street analysts betting their investment picks on this being the case.
The fact the S&P rose 25 per cent last year in the face of myriad economic and political concerns shows the hype around AI technology. So far, the stock market returns have been concentrated in the hands of the ‘magnificent seven’. The average return of Microsoft (US:MSFT), Apple (US:AAPL), Amazon (US:AMZN), Nvidia (US:NVDA), Tesla (US:TSLA), Alphabet (US:GOOG) and Meta (US:META) was 111 per cent across the year as investors gained conviction these tech giants would lead as AI winners.
The last time the S&P 500 was up more than 20 per cent in consecutive years was 1998 and 1999, the two years preceding the dot com crash. To avoid this fate again, AI will have to prove to the market that it can generate meaningful earnings for companies other than AI chip designer Nvidia.
Cloud computing investment
The positive news is that the cloud computing companies have already spent billions on AI servers. So, unlike in the 1990s, when the hype around the internet was mostly theoretical, this spending provides a durable base for AI use to proliferate from. “We are putting a lot of trust in these clouds to not only spend, but to develop and enable the Generative AI market for the masses,” wrote Melius Research’s Ben Reitzes.
Between Amazon, Alphabet, Microsoft and Oracle (US:ORCL), $122bn was spent on capex last year, an increase of 8 per cent from 2021, which was already a record year in terms of capital investment.
The main beneficiary of this dynamic in terms of earnings so far has been Nvidia with its near monopoly on graphics processing units (GPUs). These chips which enable parallel computing are essential for AI development and cloud companies have been scrambling to get their hands on them.
The expectation this year is that companies will start to utilise this increased computing capacity to integrate AI into their businesses. Wedbush Securities analyst Dan Ives has called this the “year of AI '' and expects there to be a “tech bull market” as AI use cases start to proliferate through the rest of the market. Over 50 per cent of all the companies Wedbush has surveyed said they see over 20 use cases for generative AI in their businesses, while 80 per cent say they see at least 10.
To integrate AI, companies will need to pay for a lot more cloud computing services. Microsoft is already starting to see a tangible increase in growth. The investment in ChatGPT creator OpenAI gave it a jump on its rivals. In the three months to September, Microsoft’s cloud computing division Azure grew 29 per cent year on year, of which three percentage points were directly from its AI services. The launch of Microsoft 365 Copilot, its AI enabled enterprise software product, should accelerate this growth further.
In our report, we look further into some of these trends and discuss two companies in depth that look well placed to be among the next wave of AI winners.
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