Global equities: The more AI grows,
the smaller the market could be
HOW should investors think about AI?
There is little doubt that advances in artificial intelligence technology promise to fundamentally disrupt how business is conducted, says Pendal's Samir Mehta.
But the question investors should ask is not whether the transformation will occur, but when and at what cost -- and who might benefit, he says.
"People have been overly excited by AI. But the reality is that it is not going to be instant. We are talking years before the full benefits start to materialise," says Mehta, who manages Pendal Asian Share Fund.
AI stocks have been on a tear in 2023.
Microsoft's US$10 billion investment in OpenAI, the high-profile creator of ChatGPT, has sent its shares up 40 per cent this year.
Taiwan Semiconductor Manufacturing Company -- which makes silicon chips for companies like AI giant Nvidia Corp -- is up more than 20 per cent this year as investors back its exposure to the AI boom.
But the market's excitement is divorced from reality.
Microsoft disappointed investors last month when it cautioned that revenue growth from AI would be gradual, but spending would be aggressive.
At TSMC, AI accounts for just 6 per cent of revenue, with the balance of sales coming from making chips for laptops and phones -- a market that is not growing, says Mehta.
"There are many other examples -- companies like Quanta Computer and Wistron Corp make the servers that mostly go into data centres for the operations of cloud businesses.
"Only a small part of it is being used for AI-related services. But just that association has meant that even though growth is negative in 2023 -- and expectations for 2024 and the perception that demand for AI-related servers is high -- some of these stocks have doubled in the last two or three months.
That's a speculative fervour."
Mehta says one factor counting against investors in AI is that the technology's very success could curtail demand.
Many AI services are priced on a per-user licence, leading analysts to create long term industry revenue forecasts by assuming a take-up rate among employed people.
But if AI succeeds in its promise of making business more productive, companies will reduce staffing.
"The effect of raising productivity is going to mean fewer people will need that software because fewer people are employed," he says.
Lessons from AI mania
So, what lessons can be taken from the AI mania gripping markets this year?
Mehta says the main lesson is that the ultimate beneficiaries of technological changes like AI are not always apparent early on.
"The winners are going to be quite diverse and may not turn out to be the ones that we think of intuitively," he says.
But another more immediately useful lesson for investors is that rising interest rates and tightening monetary policy may not be squeezing off liquidity as quickly as conventional wisdom would suggest.
"It is a truism that when you have a speculative mania or bubble, at the heart of it is always massive liquidity.
"The housing bubbles in the US and China, the credit card bubble in Korea, the cryptocurrency and NFC mania, those shared scooters and bikes -- invariably they are a manifestation of tremendously loose liquidity.
"So, in 2023, any perceptions that we're in a tight market environment have clearly turned out to be wrong."
Author: Samir Mehta, Senior Fund Manager
Funds operated by this manager:Pendal Focus Australian Share Fund, Pendal Global Select Fund - Class R, Pendal Horizon Sustainable Australian Share Fund, Pendal MicroCap Opportunities Fund, Pendal Sustainable Australian Fixed Interest Fund - Class R, Regnan Global Equity Impact Solutions Fund - Class R, Regnan Credit Impact Trust Fund
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