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“Over the next decade, no industry will be spared the disruption brought about by AI.”
This was the verdict of Alibaba's senior management team in its recent annual letter to shareholders.
In common with the chief executives of other major technology companies, the group has promised that artificial intelligence will “change and accelerate” its business, while warning of the significant competitive threats should Alibaba fail to keep up.
In the same week, the Economist warned that AI had become an arms race.
It pointed to the $200bn (£1.6bn) that Alphabet, Amazon, Meta and Microsoft have committed to AI spending this year, up 45 per cent on last year.
They used to call it machine learning, and Google has been using it for its search engine for 10 years. It is not a new thing
Many of those same companies have admitted that it may be years before they see a return on this investment.
No one really doubts that AI will have a transformative effect on the world. The seminal Goldman Sachs study suggested generative AI could boost global GDP by 7 per cent and lift productivity growth by 1.5 percentage points over a 10-year period. However, there are questions over the shape and timing of that transformation.
A more recent update from Goldman Sachs says: “Investment in generative AI has boomed, but it will take time for the technology to filter into the overall economy. Until we’ve seen more significant uptake in the actual application of AI, in the regular work production process, I don’t think that we’re going to see as big of an impact on productivity.”
A dose of realism
This may be the start of a more realistic appraisal of the opportunities and risks in AI. Certainly, there are signs that the market is being more discriminating.
While Nvidia's recent 262 per cent rise in revenues cheered the market, Apple and Tesla have had a far tougher time as results have disappointed. The market appears to be separating into winners and losers.
Alec Cutler, manager of the Orbis Global Balanced fund, says it is important to get AI in perspective: “They used to call it machine learning, and Google has been using it for its search engine for 10 years. It is not a new thing.
"The catalysts were Nvidia saying earnings were likely to be considerably higher than expectations and Microsoft announcing its deal with ChatGPT. We looked at the pure plays on AI. We figured out that there is a gold rush element to it, but there is also an existential risk to it.
“Right now, the market is looking at it as a positive for the primary players – Microsoft, Alphabet, Meta, Amazon, Apple. It is being framed as a new revenue generator for them.
"These companies need something to sustain their $3trn market cap. But when asked, 'What does it do?', they say, ‘It does everything... anything you can think of’. It makes people more productive. Or it replaces all the workers?
“But we question how it is going to work and whether it will generate sufficient return on capital.” This is a major question for all involved in the AI supply chain.
Cutler prefers to tap into the trend through utilities: “It’s a wonderful shot in the arm for the critical energy infrastructure theme.”
He says only two out of the five combatants are likely to come out on top: “Do you bet on all five, or do you bet on the ammo providers? That’s where we are.” He is focusing on D-ram providers such as Samsung, and chip manufacturers such as TSMC. He is less positive on Nvidia, which designs chips, but relies on TSMC to manufacture them.
Excessive spending
James Harries, manager of the Trojan Global Income fund, is also a sceptic: “We’re not going to say that the Magnificent Seven are poor companies. Absolutely not. But I do wonder whether the CapEx boom related to AI is a classic arms race. Companies don’t want to be left behind and are spending on an almost non-discretionary basis.
“They are spending like there is no tomorrow to build out the infrastructure in the hope that there will be utilisation for AI. This could lead to over-capacity. That could be quite material not just for AI and semiconductors, but for technology companies that are spending a lot of money, the returns of which are still indeterminate.”
Even AI specialists say the next stage will be more complicated.
Chris Ford, co-manager of the Sanlam Global Artificial Intelligence fund, says that while the early priority had to be the building of infrastructure, “companies can’t sell products and services until that infrastructure has been built”.
Those products and services will take time to emerge. When they do, they could be extremely disruptive and high growth, but the path will not be linear.
Markets may already be reflecting this reality. The relative growth of the large AI names versus the rest of the market has slowed, with even the unloved FTSE 100 outpacing the Nasdaq over the past three months.
The Nasdaq is up 4.43 per cent over three months, while the FTSE 100 is up 9.78 per cent. This is very short-term, but it shows that the market may be starting to change its view.
Vast investment has gone into AI infrastructure, but it is not yet clear how AI will be deployed.
Where are the life-changing use cases for it? These will almost certainly emerge, as they did with the internet, but it will take time, and companies may not see a return on their upfront investment in the short-term.
This could create volatility in the sector as investors adjust to this reality.
Darius McDermott is managing director of Chelsea Financial Services and FundCalibre
