As AI prospects move from strength to strength, CIO suggests investors maintain exposure, but balance near-term optimism against other portfolio considerations. (ddp)

Nvidia shares climbed around 10% after hours Wednesday. The firm now expects to book USD 16bn in third-quarter revenue, above already upbeat investor estimates, and sees strong AI chip demand and supply visibility into 2024.

Without taking any views on individual companies, we see several broad industry-level takeaways for investors:

AI spending is not decelerating anytime soon. The 8% year-over-year contraction in datacenter capital spending seen at top hyperscaler companies (large-scale cloud service providers) last quarter looks to already be reversing. The sharp reacceleration now under way could be sustained into next year, setting up as high as 40% year-over-year growth by the second quarter of next year and benefiting the broader AI infrastructure supply chain like memory makers, in our view. Another key read-through is that strong AI chip delivery guidance suggests concerns over supply chain bottlenecks are not materializing. With this in view, our recent forecast upgrade for the AI market to grow to USD 300bn by 2027 is beginning to look a bit conservative.

Record AI spending means services companies buying the chips will need to deliver on revenue, growth, and productivity. The AI investment wave among companies is acting as an unanticipated spur to growth even as the Federal Reserve tries to slow the US economy. As Nvidia’s CEO put it earlier this year, AI is expected to touch every industry. Investors, in turn, will want to see this AI spending translate into both tangible earnings gains and longer-term productivity, as measured by metrics like the share of income attributable to capital compared to labor. For example, within the next 3–4 years, we estimate 15% of all apps will be written by AI coding applications without significant human involvement. This structural shift could mean that large, listed tech platform companies that can afford AI infrastructure generate a higher proportion of AI-related profits than other businesses.

Continued AI outperformance means mega-cap tech is still doing the heavy lifting for US equities. For investors, stock market gains have recently been driven by concentrated outperformance from a few winners, including key AI-beneficiaries. Following Nvidia’s earnings, the reset in broader AI valuations we saw in August has likely run its course, with positive revisions and product cycles offering catalysts to support the segment once again. This may extend the risky performance concentration we’ve seen in select mega-cap names.

So, as AI prospects continue to encourage, we suggest investors maintain exposure, but balance near-term optimism against other portfolio considerations. Within equities, we continue to favor laggards whose valuations are lower and have scope to catch up—including some smaller AI beneficiaries. We keep our preference for equal-weighted US indexes compared to capitalization-weighted ones. Within tech, we think software and internet stocks are best positioned to ride the next wave of the technology cycle and the broadening of AI demand as companies try to monetize the applications driven by the underlying AI technologies. This is consistent with our tech playbook, which calls for a switch into midcycle segments like software and internet, and away from semiconductors and hardware, which have already performed well in 2023.

Main contributors - Solita Marcelli, Mark Haefele, Sundeep Gantori, Jon Gordon, Christopher Swann, Vincent Heaney

Original report - What a 'new computing era' means for your portfolio, 24 August 2023.