By Rebecca Ellis
SAT, JUNE 03 2023-theGBJournal |The contrasting emotions of fear and hope played heavily on financial markets throughout May. U.S. stocks forged ahead, with the S&P gaining 0.86% and a 6.47% leap for the tech-heavy Nasdaq as Washington scrambled to reach a deal over the debt ceiling, effectively allowing the U.S. to pay its bills. News of the agreement spurred a rally in the financial markets, particularly for risky assets.
The agreement allows the U.S. to avoid a potentially catastrophic payments default and pushes out any future squabbles over the debt ceiling to 2025. On the downside, enforced belt-tightening could dampen the impetus of federal spending that has supported US growth in recent quarters.
Some economists previously calculated a 65% chance of a recession in the coming year, and that figure may now rise. The spending cap could also influence interest rate policy as the Federal Reserve updates its growth projections. The Treasury may have to increase sales of Treasury bills to rebuild its cash balance, effectively draining liquidity from the financial system.
In the meantime, the theme of artificial intelligence continued to gain traction as investors sought an area of growth that might carry them through turbulent economic times. AI is indeed enjoying a moment in the sun. Shares in chipmaker Nvidia soared some 25% in a single day after the company issued bullish revenue forecasts and reported a jump in sales driven by soaring demand for its AI-enabling data center products.
In 2023 the AI theme has helped juice equity market returns across the board. Though shares have been buoyant overall, not all returns are equal, and if we remove top performers like Apple, Amazon, Google, Nvida and Microsoft – each an expected beneficiary of future AI-driven returns – the S&P would be down 2%, rather than up 8% for the year to the end of May.
As an investment theme, AI has been around for a while, but interest has been supercharged since Microsoft-backed Open AI presented ChatGPT last November. The seemingly all-knowing bot became the most downloaded application in history within a matter of days. Industry insiders forecast huge progress in the competence of this so-called generative AI, while regulators and politicians fret about AI stealing jobs or spreading misinformation.
The question is how to gain exposure to the AI theme without buying into the hype. Can the dotcom bubble offer any lessons?
While the Internet boom of the late 1990s did produce some big winners the ensuing market meltdown of 2000-2002 wiped out fortunes, with the Nasdaq Composite Index taking a full 15 years to regain its March 2000 peak. Thousands of startups went bankrupt, and even companies such as Intel, the toolmakers of the rapid Internet build out which were supposedly insulated from market vagaries, had to take massive inventory write-downs and reduce forecasts after many of their customers slashed spending or defaulted.
Separating the potential of AI from the pitfalls
Equity analysts may offer technical insights into market developments and even some high quality research but they are not immune from hyping the latest fad in their efforts to drive research sales.
On Zoom’s Q1 2023 results call, almost half the analysts’ questions focused on the company’s “ability to leverage AI”. Some of us still remember when “eyeballs” and page impressions drove analyst valuations, despite the companies in question offering little hope of making a profit any time soon.
Companies spent huge amounts of money to meet growth expectations, knowing that failing to do so could tank their share price. Many of them soon ran out of cash and were unable to raise any more when the bubble burst. This time too, analyst recommendations should be approached with caution.
How else can investors cut through the hype?
AI has been known as the Industrial Revolution 4.0.
History teaches us the importance of investing in the right companies when we are on the cusp of a paradigm shift – vaccine developers during the Covid pandemic being one recent example.
Instead of investing in stocks which have already taken off, it may be preferable to search deeper into the long-term trends just starting to get traction. Our analysis of several sectors flags up the following promising themes:
Services – Search engines and customer services using AI bots
Automation – robotics to improve industry and logistics
Healthcare – areas including medical imagery and computer-assisted diagnosis
Agriculture – more efficient usage of water, maximizing food production
Targeted Marketing – deep learning is expected to spur revenues
Smart management of utilities
Even so, using AI to bypass human intervention can lead to trouble. A New York lawyer got into hot water in late May when the Chat GPT-driven legal brief he produced in court was found to have cited legal cases that didn’t actually exist.
The judge was not impressed, and the lawyer may yet face consequences.
What is the best way for an investor to get the most effective exposure?
Regardless of the sector, few large companies offer a pure play on this theme. Though it would be easy enough to select the market leaders such as Microsoft, expected to generate $200 million in AI-related revenue in 2023 and $1 billion in 2024 according to Reuters, this offers a static approach to investing in the theme.
Our preference would be to select actively managed ETFs with regular rebalancing or, in their absence, active fund managers willing to look at new entrants as well as the industry leaders. Leaders in this space include Ark and Axa Framlington. We would suggest ETFs or Funds that hunt out long term cycles, where buying cheap and realizing value in the medium to long term will provide solid risk-adjusted investment returns
From one of the most intriguing sectors, Healthcare, our universe of IT-focused healthcare ETFs offered by established providers has returned between 2.7% and 6.5% year to date.
To get a feel for its abilities, we asked Chat GPT for its views on the most promising areas of AI. Here’s what it told us:
“Artificial intelligence (AI) has the potential to significantly contribute to increased efficiency across various industries. Some industries that are particularly well-suited for AI-driven efficiency improvements include:
Healthcare: AI can assist in medical diagnostics, drug discovery, patient monitoring, and personalized medicine. It can analyze large volumes of medical data, identify patterns, and provide insights to support clinical decision-making, leading to more accurate diagnoses and optimized treatments.
Manufacturing and Automation: AI can enhance manufacturing processes by optimizing supply chains, predicting maintenance needs, and improving quality control. AI-powered robots and automation systems can increase productivity, reduce errors, and streamline production processes.
Finance and Banking: AI can automate manual tasks in banking operations, such as customer service, fraud detection, risk assessment, and algorithmic trading. It can also help in financial planning, portfolio management, and personalized recommendations based on customer data and market trends.
Transportation and Logistics: AI can optimize route planning, fleet management, and supply chain operations. It can analyze data from various sources to improve efficiency in delivery scheduling, inventory management, and logistics optimization, leading to cost savings and faster deliveries.
Retail and E-commerce: AI can enhance customer experience through personalized recommendations, chatbots for customer support, and demand forecasting to optimize inventory management. It can also improve pricing strategies, marketing campaigns, and customer sentiment analysis.
Energy and Utilities: AI can optimize energy consumption, predict equipment failures, and manage smart grids. It can analyze sensor data, weather patterns, and customer behavior to optimize energy distribution, reduce waste, and improve energy efficiency.
Agriculture: AI can assist in crop monitoring, yield prediction, and precision agriculture. It can analyze data from satellites, drones, and sensors to optimize irrigation, fertilizer usage, and pest control, improving crop yields and reducing environmental impact.”
Source ChatGPT
No matter their level of risk tolerance, investors will be looking for some exposure to this fascinating and fast-growing area. However, they would do well to avoid the hype around AI and to look instead at areas where it might drive long-term value.
Diversified exposure to sectors such as healthcare, cyber security or smart grid development should yield satisfying long-term returns while simultaneously assuaging any fear of missing out.
Rebecca Ellis is Family office advisor. Co-author Martin de Sa Pinto, Martin de Sa Pinto Research
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