The S&P 500 closed out February on 5,096 points, a gain of 5.2 per cent on the month. This represents the best monthly outcome in nearly a decade, even though the index wobbled midway through proceedings as prospects for a near-term rate cut by the US Federal Reserve diminished due to the strengthening domestic jobs market.
The monthly gain was even more pronounced among the 10 most highly traded technology stocks, but the good news is that we have seen a broad-based rally on the back of encouraging earnings releases – at least across the Atlantic. Matters on this side of the pond have been rather more prosaic, although cash returns to shareholders, especially in the form of buybacks, could be a precursor (along with increased M&A) to a sustained rally in UK stocks as the year progresses.
It’s worth considering that although the S&P 500 has been on something of a tear, it is only trading slightly above its five-year average price/earnings ratio. The US stock market is far from unique in that a high proportion of its aggregate value is concentrated in a relatively small body of stocks. Where it differs is that much of the growth in this value we have witnessed since the final quarter of 2022 has been widely linked to the clamour for stocks engaged in the development of artificial intelligence (AI) technology.
Nvidia (US:NVDA) is something of a standard bearer in this regard, so the further 29 per cent valuation gain in February isn’t altogether surprising, nor news of an above-expectations increase in quarterly revenues. The sales beat drove the high-end chipmaker’s market-cap above the $2tn (£1.6bn) mark, a distinction shared by Apple (US:AAPL) and Microsoft (US:MSFT).
Yet any anxieties over “irrational exuberance” need to be set in context. After all, the development of AI technologies is being driven by the giant tech marques themselves. The debt-equity swaps synonymous with the dotcom era are not fuelling development this time around. What's more, investors probably have a much clearer idea of how AI could transform a range of industries. Although the commercial potential of the spread of online commerce didn’t exactly amount to a tabula rasa, hindsight suggests that many investment decisions were taken in hope rather than expectation – even if the likes of Jeff Bezos had some inkling of what was to come.
The extent to which AI will impact the future behaviour of investors is not so immediately obvious, and it may not be as profound as some imagine, especially if they’re intent on achieving alpha returns. The rollout of AI technologies is analogous to the spread of personal computing, the internet and mobile telephony – areas that have come to dominate whole segments of the economy. Where it differs from these other digital stepping stones is that the algorithms and computational techniques involved in machine learning could conceivably render the naked ape surplus to requirements across an unprecedented number of applications. And given the competitive advantages that could accrue through AI technologies, it’s unlikely that businesses will apply stakeholder principles where the labour force is concerned, especially if the competition is already going down the AI route.
Most of us are already invested in the development of AI tech whether we realise it or not. But investors need to develop strategies to efficiently exploit the potential applications across the economy. One point worth considering is that the regulatory frameworks governing AI technologies will probably have as great an impact as standard market forces. But it may be some time before there is clarity on this front. History has shown that government regulation, be it domestic or transnational, tends to lag innovation, especially where disruptive technologies are involved. And the ethical considerations linked to AI are still open to debate.
It’s worth restating that the advantage for investors, at least by comparison to the dotcom frenzy, is that we already have a reasonably informed view of how AI technologies will be employed, regulation notwithstanding. We will not be as reliant on supposition, nor the 'blue-sky' valuations that were another unfortunate by-product of the turn-of-the-century craze.
Instead, even as the scale of AI commercial penetration becomes clearer, standard investment considerations linked to competitive advantage, scalability and the health of company balance sheets will be much to the fore. On that last point it’s worth noting that Nvidia’s net debt is equivalent to a lowly eight times net assets – or a cash surplus of $15.2bn when the marketable securities it holds are factored into the equation. So, even if the current forward rating of 35 times consensus earnings proves to be a bit rich (and it might), you’re still exposed to a stock that arguably benefits from both value and growth characteristics.
