Tech stocks have roared back, but the current mania for artificial intelligence appears to expect too much too soon, which creates the possibility of a bubble.
Amid a first quarter of mostly mediocre growth and little in the way of guidance for the second half of the year, there was a lot of hype and hope about the future impact of AI. Big Tech stocks added more than $2 trillion in market capitalization in the first quarter, much of that based on hopes for the future and on some of these stocks now being viewed as havens in an economic storm.
Nvidia Corp. NVDA,
The theory would be that after that money surges into Nvidia, it will soon move to the companies buying the tech from Nvidia in order to live up to their AI hype. But that may not happen for years. Much of the tech sector will be in investing and spending mode for a while — which is great for Nvidia, but not a guarantee that other tech companies will soon see the same returns.
“It is somewhat unique to Nvidia,” said Daniel Newman, principal analyst and founding partner at Futurum Research. “Not only it is an arms race, it is a supply race. It’s pretty safe to say that the hyperscalers are leading this, then the biggest enterprises are next. They are trying to get their hands on every system they can get. They don’t know entirely why yet, they just know they need all the computing power they can get, every scrap of inventory they can get their hands on.”
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Newman likened the current spending spree on AI systems to building a structure when steel is in short supply. “So they are buying all the steel they can get their hands on and just laying it down on the job site.”
The rebound in tech stocks has pushed the Nasdaq Composite Index COMP,
Did earnings justify the tech-stock rebound?
As tech earnings season nears an end, we have seen stocks rise more than the results. The combined results from Alphabet Inc. GOOG,
Net income fared slightly better, rising 7.5% to a combined net of $66.4 billion, up from $61.7 billion a year ago, but per-share earnings for Big Tech fell 5.3% from the same period in 2022 as companies continue to grow their share counts through stock compensation. Big Tech has so far outpaced the overall S&P 500 in revenue growth but saw a sharper decline in EPS.
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Investors and analysts were still relieved by those results. After a $2 trillion rebound in the first quarter, shares of four of the top five companies were trading on average about 40% higher year to date, with Meta stock more than doubling as Wall Street applauded its massive cost-cutting moves. Both Alphabet and Apple hit 52-week highs last week. Nvidia, now close to reaching $1 trillion in market cap, may join the ranks of Big Tech soon, but it is not included in this data.
Wedbush Securities analyst Dan Ives called the quarter “a much better-than-feared earnings season for tech.” Overall strength in cloud computing helped Microsoft beat estimates amid a huge decline in the PC market, but Amazon signaled some concerns about AWS. A more stabilized internet advertising market helped Alphabet’s Google search and ad business. Meta saw its earnings decline, with only slight revenue growth, as the Facebook parent cut costs, but it gave a better-than-expected forecast. Apple saw a surprise jump in iPhone sales, fueled in part by strong performance in emerging markets.
“ ‘The economy has shown incredible resiliency over the past two quarters despite huge issues such as a banking crisis. Yet it’s quite possible that the wheels could fall off the bus with [third-quarter] earnings.’ ”
— Maribel Lopez, Lopez Research principal analyst
“We were told it was going to be horrible, the market was going to crater, and what we saw was that tech is going to be more resilient,” Futurum’s Newman said.
Results from the largest tech companies papered over some overall weakness, however. According to Credit Suisse’s senior equities strategist, Manish Bangard, earnings for all tech companies included in the S&P 500 have underperformed when compared with the overall S&P 500 SPX,
Two weeks ago, with 85% of companies having reported, Bangard noted that revenue growth for S&P 500 companies was 3.7% and EPS was down 2.4%, while tech companies in the index saw revenue fall 3.1% and EPS fall 12%. The data did not include results from Nvidia and several others that reported this week.
The first quarter also saw many companies meeting or beating lowered expectations, and estimates are still being cut. According to FactSet and a MarketWatch analysis, analysts have cut their earnings estimates for half of the 72 tech companies in the S&P 500 since December. They have also cut estimates for 44 of those companies for 2024.
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As this column noted last month, the first-quarter earnings season for some tech companies was expected to be buoyed by cloud-computing projects, with one analyst noting she was worried about the summer.
“The economy has shown incredible resiliency over the past two quarters despite huge issues such as a banking crisis,” Maribel Lopez, principal analyst at Lopez Research, said in a recent email. “Yet it’s quite possible that the wheels could fall off the bus with [third-quarter] earnings. We see softening demand in areas such as retail, housing etc., which can’t be good for the overall economy.”
Indeed, the macroeconomy, jitters about the state of some regional banks and a looming debt-ceiling crisis are adding uncertainty to the mix, with some companies such as Apple citing macroeconomic uncertainty as the reason they are not giving much of a forecast. None of the Big Tech companies have provided a full annual forecast, with many executives citing the uncertain economic environment for the lack of more guidance.
Even Nvidia, which made the markets move with its forecast, declined to give guidance beyond the current quarter. When MarketWatch asked Nvidia Chief Financial Officer Colette Kress directly about her view beyond the current quarter, she would only say, “We have procured a substantial supply for the second half of the year. We have better visibility for a few quarters out. That is about as much as we can articulate now.”
Generative AI is now the ‘all-weather sport’
Newman noted that while investors are concerned about the macroeconomy, tech in many cases is going to be more appealing, especially now with the massive focus on AI. And Nvidia’s monster projection showed the promise of the technology.
Newman described the focus on generative AI as an “all-weather sport.” He also believes that generative AI, because it is being tested by the public in applications like Open AI’s ChatGPT and Google’s Bard, will be a great democratizer.
“It is being made available to companies smaller than ever before,” he said. “AI is going to find its way into companies, and it’s going to be the fastest disruption we have seen.”
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On top of software companies like Microsoft MSFT,
Quarterly reports were in some cases overshadowed by talk about artificial intelligence, but investors should know that the costs will arrive well before the benefits. Microsoft executives, for example, talked about higher capital spending on AI efforts. Alphabet too talked about higher spending for its data-center infrastructure, with AI also a part of that spending.
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This is where the possibility of a bubble exists. While investors are betting that other companies will soon see the same type of returns on AI that Nvidia expects this quarter, those companies may actually be shipping their money to Nvidia in hopes of getting a return years down the line. Wall Street expects earnings and revenue growth to turn around in the second half of the year, but if most of the tech sector is focused on spending to build for the future, that will not happen.
So while AI captured the most attention from investors this earnings season, especially after the Nvidia euphoria, they need to remember that there could be turbulence for the next few quarters. And spending on AI itself is going to mean a big investment cycle before some rewards are seen. Meanwhile, regulators are looking at whether they can put any guardrails on AI applications at this point.
Big Tech may be a haven for investors right now, with some caveats. As Newman pointed out, there has been a disproportionate flow of money into the big names, because “they have the most competitive technological moats.”
That applies to long-term bets, though. If Wall Street estimates are any indication of the rest of the year, they are pointing generally to continued lowered expectations. And if the numbers we see the rest of the year fail to compare to Nvidia’s monster forecast, the trillions poured into tech so far in 2023 could disappear just as fast.