The AI trade is still strong. Investors have to go along for the ride.
Investors that want to beat the S&P 500 likely have to stay invested in big tech while looking to make outsize bets elsewhere.
Nearly all of the big tech companies have reported earnings this season, and while stock reactions have been mixed, the overall artificial intelligence trade appears to be intact.
Even if it looks different going forward, it is still hard to argue against owning the Magnificent Seven—or even the Great Eight.
For one, it seems clear the catalysts are still in place to fuel further gains. Demand for AI remains strong, and that makes investors more comfortable with the huge amounts of spending being devoted to its development.
It is true that it is a lot of money, even for the deepest pockets. Yet as Capital Economics’ Jonas Goltermann notes, the fact that high costs of data center buildouts will necessitate more debt going forward alone doesn’t change their view the AI-boom has further to run.
“Judging by the earnings season so far, there are few signs that tech earnings or AI demand are faltering," wrote Goltermann, deputy chief markets economist. Moreover this comes as “other sectors of the stock market have struggled to keep up recently."
Concerned investors may point to the Federal Reserve, which has taken on a more hawkish tone of late—fewer than expected interest-rate cuts would be a headwind not only for all companies taking on debt, but riskier assets in general.
Yet Goltermann again doesn’t think that is enough to stall the rally. Even without as much easing as anticipated, the AI boom is still supported by robust U.S. growth, meaning he doubts “recent jitters around the funding of the data centre build-out, or the continued narrowing of the stock market rally, presage a major setback."
Moreover, it is hard for individual investors not to have exposure to the biggest tech stocks, given their weight in the index and contribution to this bull market’s returns.
Trivariate Research President Adam Parker takes a look at the “Great 8," i.e. the Magnificent Seven stocks—Alphabet, Amazon.com, Apple, Meta Platforms, Microsoft, Nvidia, and Tesla—plus Broadcom. He notes they are now 41.2% of the S&P 500’s market capitalization, but 55% on a beta-adjusted basis.
“For investors trying to beat the S&P500, it is crucial to get these names right," he writes. But the problem is “the correlation of returns of these stocks appears to be cyclical, but hard to time."
Put another way, these stocks account for so much of the index’s returns, investors can’t afford to get the timing wrong, but the market reactions to news and the correlations to one another change so rapidly that he “highly doubt[s] that fundamental analysts can call the quarters of these companies consistently well and then position capital…with this much quarter-to-quarter performance deviation."
Not to mention that with hundreds of analysts covering these stocks on the buy and sell side, it is hard to uncover anything new about them.
Therefore investors that want to beat the S&P 500 likely have to stay invested in big tech while looking to make outsize bets elsewhere.
In short, AI continues to be one of the best games in town, and big tech stocks reflect that. If investors want to beat them, they have to join them first, and then figure out ways to differentiate their portfolios.
Write to Teresa Rivas at teresa.rivas@barrons.com
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