- AI capital investment boom is driving interest in tech stocks and the Mag7
- Other US equity sectors are benefiting too
- If the AI splurge falters it could therefore have wider implications
- Economically sensitive sectors are already showing weakness
- Capex remains relatively low in mining and oil
“Many a stock market boom, from American railroads in the nineteenth century to broadband and 3G mobile telecoms equipment in the late twentieth, has been fuelled by substantial capital investment in the latest technology and hopes for the associated productivity benefits, and the strong performance of shares in artificial intelligence-related companies feels no different,” says AJ Bell investment director Russ Mould.
“This does not mean that a bubble is certain to burst, or that all AI plays are doomed to failure, but it does mean investors need to proceed with caution, and perhaps also look at areas where there is much less investment, as that is where future profits could benefit from finite supply, at least if the end-market is not permanently in decline.
“Chief executives such as Jensen Huang of Nvidia and Alex Karp of Palantir have been quick to push back on talk of bubbles in the AI industry, but their companies’ share prices have pulled back a little all the same. Some investors have looked on nervously at both the profits they have accrued in the stocks, and the spending plans of the biggest AI players. For some, previously copious free cash flow is drying up. For others, the funding sources remain unclear, if not downright opaque.
“All of this brings into relief once more the lop-sided nature of the US equity market. Technology and AI-related stocks dominate, often in unexpected ways. Meanwhile, marked underperformance from sectors such as Industrials, Financials and Real Estate suggest America’s economic outlook may not be as robust as it seems. Yet these sectors’ faltering returns could mean they are worthy of further research, just as many of these sectors were when Covid-19 and lockdowns were doing their worst or when investors were looking at technology, media and telecoms (TMT) stocks between 1998-2000, to the apparent exclusion of all else.
“On a five-year view, the S&P 500 looks reasonably balanced with Energy and Financial stocks among the vanguard, alongside Information Technology and Communications Services and Industrials. This mix flags not only American dominance in tech and AI, but also the strong nature of the economic rebound post-Covid, not to mention the value that can be accrued by buying sectors when their fortunes are at their lowest ebb and valuations are washed out (as was the case with Energy and Financials back in 2020).
“But a one-year view leaves the US equity market’s foundations looking more reliant on a narrower leadership group.
Source: LSEG Refinitiv data.
“The presence of Communications Services at the top of the one-year performance list is a bit deceptive, too, as this traditionally ‘defensive’ sector’s three largest stocks are Alphabet, Meta Platforms and Netflix. Information Technology, dominated by Nvidia, Apple and Microsoft speaks for itself. However, two of the three biggest Consumer Discretionary names are Amazon and Tesla, and Utilities are doing well as investors ponder who will provide the energy that powers and cools the data centres and servers needed for the computing and inference capabilities of the large language models that underpin AI.
“Again, the contrastingly poor showing from cyclical sectors jumps out, as do the turgid returns from the Energy and Materials sectors in the past 12 months. Weak oil and gas prices are not helping the former, while the latter may well be worried about tariffs and global trade.
“The net result of these trends is that the Magnificent Seven of Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla now represent 37% of the S&P 500’s stock market capitalisation between them. At the other end of the scale, the Energy sector is now worth just 2.9% of the headline index and Materials just 1.7%, even if the importance of energy and resource independence seems clearer than ever in light of the war in Ukraine, fragile peace in the Middle East and ongoing tensions over the supply of critical minerals with China.
Source: LSEG Refinitiv data.
Source: LSEG Refinitiv data.
“Granted, the S&P 500 Materials sector is not a pure play on mining and metals, as steels, chemicals and other cyclical industries feature (many of them the ones that President Trump’s tariff plans are trying to prop up and save). But the lack of interest in both sectors is startling, especially when their spending discipline and frugality contrasts so markedly with the tidal wave of spending unleashed by those who are scrambling to cement a leading position in AI. Such is the scale of their outlay, that investors are becoming more nervous about funding and the returns that may be accrued, with some even wondering whether there could be a spending bust to match that witnessed when the technology, media and telecoms bubble collapsed in the early 2000s.
Source: Company accounts, Marketscreener, analysts’ consensus forecasts for Alphabet, Amazon, Meta Platforms, Microsoft and Oracle.
“Big oil is exercising considerable restraint when it comes to capital investment, and that spending includes renewables and not just oil and gas fields. It seems logical to assume that supply of hydrocarbons will only grow slowly, and that it will take time to bring on new fields, even if demand for energy worldwide continues to grow. The danger to big oil and gas here remains that alternative, renewable sources of energy lead the charge. For the moment, the major hydrocarbon producers seem to be recalibrating their plans here, which could also be a potential opportunity for patient, contrarian investors.
Source: Company accounts, Marketscreener, consensus analysts' forecasts for BP, Chevron, ConocoPhillips, ENI, ExxonMobil, Shell and TotalEnergies.
“The same could be said for metals. Mines cannot be developed at the flick of a switch. The spending boom for the early 2000s sowed the seeds for the commodity price weakness of the 2010s, but there has now been a decade of restraint.
Source: Company accounts, Marketscreener, consensus analysts' forecasts for Freeport-McMoRan and Newmont.
“This lack of supply could prove telling if demand picks up, thanks to wider economic growth, the electrification trend, or even just demand from investors who may feel they trust ‘hard’ assets more than paper promises, such as cash and bonds – especially if inflation rips higher or Western governments continue to rack up fresh borrowing.”
Source: Company accounts, Marketscreener, consensus analysts' forecasts for Anglo American, Antofagasta, Endeavour Mining, Fresnillo, Glencore, Rio Tinto and BHP.
