Note: This is an explainer of the current financial trends for purely educational and informative purposes, and is not meant as investment advice.
Introduction
In June 2020, Open-AI finally released Chat-GPT 3, after numerous iterations and significant improvements from the previous models. Despite not being the first within the publicly accessible AI software space, Chat-GPT 3 took the world by storm. Within months, it was integrated into many aspects of our society. Students utilised its advanced natural language processing abilities to assist in essay assignments, e-commerce businesses leveraged on its machine learning capabilities to implement online chatbots, and social media users posted impressive images generated by AI using simple text commands. The release of Chat-GPT 3 was significant as it provided the general public with direct exposure and access to the full capabilities of AI technology unlike any other software before. Since then, investors’ interest in AI and its place in our future has kept up a steady momentum. The results of this can be seen in securities exchanges and markets across the globe, with companies riding on this AI revolution experiencing significant increases in valuation. The question, however, is whether this exponential growth experienced amongst tech companies is sustainable or just a bubble waiting to burst? To answer this question, we must first understand the reason behind why businesses have gravitated towards AI technology and the services it provides.
The AI Wave
The power of AI lies in its ability to take in, process and interpret vast amounts of data in a very short amount of time, far beyond what a human is capable of. Already within the e-commerce space, big names like Amazon, Netflix, Spotify and Apple have been at the forefront of AI use in analysing customer data. For example, Amazon uses AI to analyse customer activity and historical purchases to provide curated product recommendations. Have you ever googled a product and within 5 minutes, been bombarded with Amazon promotions of that same product? Yup, that’s AI at work! Spotify on the other hand employs complex AI algorithms that interpret your recently played songs to make personalised suggestions for music you have yet to listen to. Within the social media space, apps like Tik-Tok, Instagram and Snapchat carefully curate the content you see on your feed based on your interests, as gathered from your previous in-app and even cross-app activity. This is to keep you scrolling and improve overall user retention.
Demand for AI software has also benefited from the increased popularity of self-driving vehicles. With companies like Tesla and Ford configuring it to enable road navigation and traffic, without you needing to so much as touch the steering wheel. As for financial institutions, AI has been seen as a way to improve the accuracy and speed of investment analysis. For instance, hedge funds have learnt to integrate AI into their investment strategies by using it to predict potential stock price changes based on many factors, including economic indicators, geopolitical events and even social media sentiment. This has provided these firms with a competitive edge in predicting market shifts. Essentially, AI technology has been utilised across numerous industries, companies and aspects of running a business. Unsurprisingly, this burst in demand for AI tech has generated great earnings for companies that stand to gain the most from future AI development.
Market Analysis
The large rally experienced by financial markets this year has been primarily driven by the increased enthusiasm in AI development. As shown in figure 1, the IT sector drove approximately two thirds of the S&P 500 performance, an index tracking the stock performance of 500 of the largest companies listed on stock exchanges in the United States. This growth was led by the 179% return for NVIDIA, 134% return for Meta Platforms, and 109% return for Tesla, all companies that have revealed AI integration as one of its main growth drivers for the coming future. The IT sector has also contributed 76% of the overall 4.79% return year-to-date of the MSCI Emerging Markets Index, an index that tracks mid-cap and large-cap stocks in 25 countries across emerging markets. This was largely due to significant AI component manufacturers and service providers located within the region, such as Taiwan Semiconductor Manufacturing (TSMC) and Tencent.
Figure 1: IT sector contribution to year-to-date returns of index’s
Undoubtedly, the tech firm that gained the most, Nvidia, has greatly exceeded expectations by achieving a market capitalization growth of almost 100% in just 9 months and eventually reaching 1 trillion dollars in May. At the core of its business is its specialisation in generative AI, which it has integrated into its service and product line. From GPU hardware, AI driven business solutions, and cloud computing services, Nvidia has become many businesses’ go-to destination for incorporating generative AI into their day-to-day operations.
Certain tech stocks, along with Nvidia, have performed so well recently that they were labelled “the magnificent seven”. Coined by Bank of America analyst Michael Hartnett, this phrase refers to seven tech stocks that have run circles around the benchmark S&P 500 and brought the index into a bull market. These seven stocks consist of Nvidia (semiconductors), Microsoft (software & cloud computing), Amazon (e-commerce & cloud computing), Meta Platforms (social media), Alphabet (Google parent), Apple (iPhones & iPads), and Tesla (electric vehicles & solar power).
Figure 2: Market Capitalization of Nvidia
Figure 3 displays the explosive growth the “magnificent seven” stocks have experienced, with the S&P 500 performance as a benchmark. Analysts have stated that these explosive stocks are the main reason as to why the S&P 500 has been as bullish as it has, despite rising interest rates, tightening consumer spending and market uncertainty.
Figure 3: Year-to-date returns of the S&P500 and the equally weighted ‘Magnificent Seven’ stocks
Elsewhere in the tech sector, SoftBank-owned chip designer Arm, is in the midst of going public with a valuation of $52 billion, making it the largest US initial public offering (IPO) in the last two years. Arm Ltd has greatly benefitted from the AI wave as its main product offerings consist of designs for computer processing units (CPUs) which are the backbone of AI technology today. With a market share of more than 99% and an average gross margin (profit as a percentage of revenue) of 95%, investors are confident that Arm will continue its dominance within the emerging tech sector.
Sustainable Growth or Just Hype?
Amid this recent AI hype amongst investors, there also exists scrutiny on the sustainability of it and whether a severe correction – reminiscent of the dot.com bubble burst in the early 2000s – is in the works. For instance, many experts from Wall Street banks such as UBS and Bank of America, have cautioned investors over overvalued companies that claim to lead the way in optimising AI for growth and profitability. The fear is that these companies are receiving historic valuation increases based on speculation instead of fundamental analysis.This poses an eerie similarity to the period between 1995 and 2000, when investors pumped money into internet-based startups in the hopes that these fledgling companies would soon turn a profit. And when the vast majority of these ventures ultimately fell short, they failed, swallowing roughly $5 trillion in fundraising. However, a notable difference between the recent AI hype and the dot.com bubble is that within the AI industry, the big players comprise of well-established companies with successful track records. In contrast, the dot.com bubble was led by newly-founded startups with no historical performance, and a business model solely reliant on one product. Moreover, these AI related companies are also heavily backed by veteran entrepreneurs from Silicon Valley, such as Elon Musk (Tesla), Tim Cook (Apple) and Sundar Pichai (Google).
Another point of worry is that market concentration along the supply chain, particularly amongst upstream suppliers, pose significant geopolitical risk. As exhibited in figure 4, the foundry market is heavily concentrated. Foundry refers to the process wherein silicon wafers are manufactured. These wafers form the foundation of microchips, which are essential for housing the microscopic and delicate transistors and other miniscule components that power AI. The Taiwan Semiconductor Manufacturing Company boasted a 55.5% market share last year. This places the future of the AI upstream supply under great uncertainty as the US-China tensions continue to grow. With China declaring intentions on invading Taiwan and the Biden administration banning investments in China’s tech sector, the world’s supply of microchips may be at risk.
Figure 4: Top Ten Foundry Companies by Market Cap (2022)
Conclusion
All-in-all, AI development remains a hotly debated topic. Some rejoice at the potential future of innovative consumer products that will make our day-to-day lives more efficient and convenient, whilst others are fearful of the consequences it may bring for traditional occupations that are in danger of AI automation. Nevertheless, it is imperative to ensure balance between embracing the many advantages of AI while addressing its associated disadvantages. Thus, shaping a future where AI enhances human lives ethically and responsibly.
References
Find someone who loves you like hedge funds love Nvidia | Financial Times (ft.com)
https://www.forbes.com/advisor/business/software/ai-in-business/
US stock market needs more than the Magnificent Seven | Financial Times (ft.com)
https://www.lazardasHow AI Can Protect and Improve Your Business | Entrepreneursetmanagement.com/research-insights/outlooks/emerging-markets#:~:text=Summary,of%20ever%2Dchanging%20investment%20opportunities.
https://www.reuters.com/technology/nvidia-sets-eye-1-trillion-market-value-2023-05-30/
https://www.macrotrends.net/stocks/charts/NVDA/nvidia/market-cap
https://www.ft.com/content/36bc706f-66a1-48e3-8c20-ab4966cb0fce
https://futurism.com/ai-dot-com-bubble
https://www.idc.com/getdoc.jsp?containerId=prAP50994023
Researcher(s): Ishmael Kamal
Reviewers(s): Maryam Nazir Chaudhary
Editor(s): Malcolm Wong Jun Xiang, Anura Sofea
Designer(s): Nur Farihatun Nisa, Isabel Yap, Kang Yi Yao
