CIO believes tech giants with superior pricing power and strong margins are relatively well positioned given their dominant market share, track record, and high return on invested capital. (UBS)

Amazon provided an improved forecast for its first quarter in 2024 and spoke of cost reduction benefits and strong consumer spending despite increasing credit card debt and delinquencies. Meta announced its first dividend, plans to buy back shares, and stronger-than-expected guidance for the first quarter. Finally, Apple reported results that were in line with forecasts, though disappointing sales in China were a concern.

That followed news earlier in the week from Microsoft and Alphabet, both of which narrowly beat revenue and earnings estimates. The news was not all positive, however. Alphabet’s search advertising businesses disappointed, and Microsoft’s revenue and earnings beats were not as strong as in previous quarters. Chipmaker AMD forecast a disappointing revenue outlook for the first quarter.

Against a backdrop of elevated expectations for tech and growth companies, the “Magnificent Seven” have fallen 1% over the past week through Thursday's close, trimming their gain so far in 2024 to 4%following a 76% rally in 2023.

But overall, the latest results highlight that companies with a clear AI roadmap are benefiting from secular tailwinds. We believe the investment case on tech, including AI, remains intact and recommend investors use any undue correction in quality AI leaders as a buying opportunity.

AI monetization is improving, and capex trends remain strong. Without taking any single name views, Microsoft and Alphabet reported accelerating cloud growth compared to previous quarters, thanks to rising contributions from AI. Moreover, we are also witnessing a broad-based increase in AI-related capex.

Currently, we believe most of the AI-related spending is concentrated in the infrastructure layer given the need to build and train huge datasets. Microsoft and Alphabet’s strong commitment to increasing AI capex and comments from TSMC and Meta CEO Mark Zuckerberg on the demand for AI-related chips support our positive near-term view on AI infrastructure. During 2022–27, we forecast a 50% compound annual growth rate (CAGR) for infrastructure spending, driven by emerging trends around the use of graphics processing units in cloud servers and AI edge-computing.

With broadening AI demand and rising monetization trends, we expect the applications and models segment to emerge as the dominant force in the medium to long term. We see a 152% CAGR during 2022–27 for AI applications and models. Overall, we forecast global AI revenues to increase fifteenfold between 2022 and 2027, from USD 28 billion to USD 420 billion.

Fundamentals of global tech companies are intact. Strong volume growth and AI-related tailwinds have prompted us to raise our global tech (IT and internet) 2024 earnings per share growth forecast from 16% year-on-year to 18%. Global tech’s valuation of around 25 times forward price-to-earnings is not cheap, but we believe the premium is justified given our expectation of lower rates and stronger earnings growth for 2024.

Software and semis should be key beneficiaries of an AI upcycle. We turned positive on global semiconductor manufacturers in October 2023 given our view of robust and broadening AI demand. We continue to believe that the semiconductor and software industries are well positioned to ride the AI wave. We expect both industries to post solid double-digit profit growth (50% profit growth for semiconductors and close to 20% for software) and expect operating margins of more than 30% in 2024.\

The Semiconductor Industry Association’s expectation of double-digit sales growth of semiconductor chips—due to improving end-market demand in AI, PCs, and smartphones—supports our view of improving demand.

So, with AI set to remain the key theme driving global tech stocks again this year and likely the rest of the decade, we maintain our preference for the semiconductor and software industries. We see opportunities in those involved in memory and AI edge-computing. Overall, we like the US tech sector, which aligns with our quality tilt and offers exposure to compelling disruptive trends. Specifically, we believe tech giants with superior pricing power and strong margins are relatively well positioned given their dominant market share, track record, and high return on invested capital.

Main contributors – Solita Marcelli, Mark Haefele, Sundeep Gantori, Krishna Goradia, Daisy Tseng

Read the original report : The investment case for AI is still intact, 2 February 2024.