Getting smart about AI as a long-term investor
Enthusiasm over artificial intelligence-related (AI) stocks has been a big driver behind the rally in equity markets this year. But beyond the recent runup, there is longer-term potential in the trend. In this month’s CIO Insights, we take a broader look at the implications of this transformative technology.
Here are our main takeaways:
- Valuations have come up for a few mega-cap tech stocks, causing some investor concern over whether there is a bubble forming in the AI sector. But broader market data shows that this isn’t the case.
- From a long-term perspective, the adoption of AI has broader implications for economies, sectors and companies, which is what we – as long-term investors – are most excited about.
- From an investment perspective, tech companies tied to AI developments are the ones poised to directly benefit. The good news is that if you’re invested in broad-based equity indexes, you already have significant exposure to this trend.
First, some background on the tech rally
A rally in large-cap technology stocks has been underway since the start of the year. That’s partly been fuelled by macro factors, including:
- Expectations of the end of the US Federal Reserve’s rate hike cycle;
- Higher liquidity as central banks backstopped turmoil in the banking sector; and
- Investors’ “flight to safety” to big tech companies with cash-rich balance sheets.
Over the past few months, heightened investor inflows into companies with exposure to AI have driven this upswing. For example, Microsoft has seen its share price climb 40% this year thanks to robust earnings, but it’s also been aided by investor expectations that its multi-billion dollar investment in OpenAI – the company behind ChatGPT – could boost future profits even more. Meanwhile, semiconductor manufacturer Nvidia has seen its share price surge nearly 200% since the start of 2023 as investors bet that its products and services position the firm as a key beneficiary of the AI wave.
Without the gains of these tech-related stocks, the S&P 500’s performance would be flat to negative, while the tech-heavy Nasdaq’s rally would be cut in half. This can be seen in the chart below.
Despite the hype, data suggests AI isn’t in a bubble
The excitement over AI has pushed up stock prices as investors see promise in its potential to boost future profits. For example, Microsoft’s forward 12-month price/earnings ratio (P/E) – a gauge of investors’ valuation based on potential earnings – has climbed to 35x, while Nvidia’s P/E surged to nearly 65x at its peak in late May.
While a few stocks may be over-extended, data shows that the broader market isn’t in a bubble, and is still trading at reasonable valuations. The forward P/E for the tech-heavy Nasdaq index has run up to 28x as of mid-June from a trough of about 20x last year. But that’s still below a recent peak of about 32x in 2021, and well below a P/E of 75x during the height of the dot-com bubble. The figure for the S&P 500, meanwhile, has risen to around 20x – not too far from its long-term average of around 18x.
The bigger picture: AI is game-changing technology
Is the market right to focus on just a handful of companies? Will AI be as transformative as the internet was? For us at StashAway, one thing is clear: AI has the potential to transform society (and the economy) as we know it. This technology is part and parcel of what analysts call the Fourth Industrial Revolution, in which new innovations will transform how people work, how companies innovate, and how economies grow.
Transforming the labour market
Recent developments in AI are expected to result in dramatic shifts in global labour markets. Research from Goldman Sachs suggests that these advances could expose about 300 million jobs to automation. While a share of those roles will be fully replaced, AI is more likely to be a complement rather than a substitute for workers. Other studies point in a similar direction: a survey conducted by the World Economic Forum showed that 50% of companies expect AI to result in net job growth, while only 25% see it leading to job losses.
The bottom line is that there will be new jobs, but they will look very different from those that are around today. After all, research from MIT economist David Autor shows that 60% of workers today are employed in jobs that didn’t exist in 1940.
Lifting company profits and encouraging innovation
For businesses, AI has the potential to significantly increase efficiency by helping to automate and optimise processes, as well as speed up analyses of vast amounts of information. This can contribute to greater cost savings, faster decision making, and, ultimately, higher profits – creating conditions under which firms can innovate quickly. Goldman Sachs estimates that generative AI could lift productivity by 1.5% per year over the next decade, which could translate to a 30% increase in S&P 500 profits over that period.
Boosting the broader economy
Over the long run, economic growth is powered by three main factors: capital, labour and productivity. If we zoom in on productivity, we see that economic gains are made when new technologies help people or machines increase output with the same amount of resources – as was the case with the steam engine and the internet. In doing so, AI is expected to add trillions of dollars to global GDP – Goldman Sachs projects a 7% lift (amounting to US$7 trillion) over the next decade. Recent research by McKinsey estimates that generative AI could add up to US$4.4 trillion annually to the global economy – that’s more than the United Kingdom’s entire GDP in 2021.
Increased adoption of AI also comes at an opportune time, as ageing populations in a number of countries – such as South Korea, Singapore, and Japan – are putting pressure on economic growth. Fortunately, companies and governments have already taken strides to boost automation: “robot density” (the number of robots per 100 workers) in these countries stands at 10x, 6.7x, and 4x, respectively, well above the world average of 1.4x.
That said, AI adoption is still relatively nascent, as we can see from the S-curve below, which charts the typical adoption path of new technologies and trends. AI sits on the shallow end of the curve where early adopters are buying in, but it’s on the cusp of edging over into exponential growth.
How can investors benefit from this trend?
As with other exciting technological developments, initially, most of the returns will come from certain companies and sectors where the benefits are the most straightforward. In this case, a handful of mega-cap tech companies are the obvious immediate winners because they can afford the high costs of developing the large language models (LLMs) powering generative AI. However, as AI usage becomes more widespread, the next beneficiaries will be “adjacent” companies and sectors (for example, the broader tech supply chain), or firms that can quickly adapt to technology (those in consumer services or financial services).
The good news is that broad-based equity indexes already offer significant exposure to these companies – we estimate that tech and adjacent industries currently comprise 46% of the MSCI China equity index and 42% of the S&P 500.
Methodology note: Index exposure aggregates the weights of companies in the information technology and communication services sectors, as well as other related sectors (i.e., broadline retail, payment processing, etc.). The US refers to the S&P 500, while the other regions refer to the relevant MSCI equity index.
Investing in AI is about playing the long game
One of our key takeaways: for early-stage technologies like AI, it’s extremely difficult to pick the winners. But, as the chart above shows, if you’re invested in these broad-based equity indexes, you’ll already have exposure to this trend. Our General Investing portfolios powered by StashAway and BlackRock® provide such broad-based exposure. What’s more, since these indexes are market capitalisation-weighted, they’ll automatically adjust to reflect changes in the market. So by staying invested, you’ll remain exposed to the companies that could become future winners.
But if you do feel strongly about a particular area of AI, our Flexible Portfolios allow you to incorporate assets from specific sub-sectors, like robotics, cloud computing, or semiconductors. Our Technology Enablers thematic portfolio also offers more targeted exposure to AI and related sectors, along with “balancing assets”, like gold, to help protect against downside risk.
Periods of rapid technological change can be disruptive, but it’s important to remember that ultimately, they have benefited our overall quality of life. It can be tempting to make big bets on how these trends will play out, but we believe that staying invested in a diversified portfolio for the long-term can still be a winning strategy when it comes to AI.
For StashAway General Investing portfolios that are powered by BlackRock, BlackRock provides StashAway with non-binding asset allocation guidance. StashAway manages and provides these portfolios to you, meaning BlackRock does not provide any service or product to you, nor has BlackRock considered the suitability of its asset allocations against your individual needs, objectives, and risk tolerance. As such, the asset allocations that BlackRock provides do not constitute investment advice, or an offer to sell or buy any securities.
BlackRock® is a registered trademark of BlackRock, Inc. and its affiliates (“BlackRock”) and is used under licence. BlackRock is not affiliated with StashAway and therefore makes no representations or warranties regarding the advisability of investing in any product or service offered by StashAway. BlackRock has no obligation or liability in connection with the operation, marketing, trading or sale of such product or service nor does BlackRock have any obligation or liability to any client or customer of StashAway.
We thought you might.
Join the hundreds of thousands of people who are taking control of their personal finances and investments with tips and market insights delivered straight to their inboxes.