GAM Investments’ Mark Hawtin explains why, following a surge in AI-related share prices, he is reassessing the ‘picks & shovels’ approach to the sector. Mark also discusses why he is taking advantage of attractive valuations to dig deeper into China’s disruptors.
Despite all the fundamental headwinds, US equities have pushed higher over the first three quarters of 2023. Even as the Federal Reserve (Fed) raised interest rates to 22-year highs, and hinted that at least one other hike could be on the agenda during the fourth quarter, the market has driven relentlessly higher.
While there has been a focus on quality, and to some degree market capitalisation, the tech-oriented so-called “Magnificent Seven” – that is Apple, Microsoft, Nvidia, Amazon, Tesla, Alphabet and Meta (formerly known as Facebook) – have been in the driving seat. Amazingly, those seven stocks have collectively accounted for around 60% of the S&P 500 index’s returns so far this year. In fact, while the S&P 500 is up by over 7.5% to October 3rd, the S&P 500 Equal Weight index is down for the year, showing that the broader market universe has struggled to make any headway.
Back in May, chip specialist Nvidia’s first-quarter earnings report generated the first real artificial intelligence (AI) performance surge. Nvidia’s blockbuster earnings triggered a 20% jump in its share price and peer Marvell saw a similar move after reporting the following day. More recently, we have begun to get traction in other AI names and more generally the kind of futuristic thematic areas that we very much focus on.
Positioning for turbulence in AI’s rapid ascent
While there is no doubting that so much of the potential of AI is becoming reality, and there has been huge demand for chipsets as people have rushed to build out their capability, we have recently taken the view that the valuations across the infrastructure side of AI have been looking a little ‘bubbly’. A bit like the internet of the late 90s, or even the US railroads in the early 1800s, lots of participants have adopted the ‘build and they will come’ mindset, backing the rapid infrastructure rollout on the basis that the users will follow as a matter of course. But, as dot.com investors may recall, valuations can sometimes get very far ahead of reality, and can come back to earth with a bump, even in technologies that see massive subsequent uptake. We have seen fairly strong rates of uptake in AI, and we expect the growth to continue. But we think that following the accelerated ordering of chipsets – to the extent that they have been difficult to get hold of – we think there is scope for an air pocket on the demand side for hardware, at least until such time as end user demand catches up. So while we see potential for some share price turbulence on the hardware side, we have been looking for other ways to capture the theme of AI opportunity, in particular on the AI software-as-a-service (SaaS) side.
Doom-mongering on China presents compelling valuations
From disappointing levels of post-Covid consumer spending, weaker-than-expected economic growth and major stress in the debt-ladened real estate sector, the flow of bad news on China’s economy just keeps coming. But while the relentless flow of gloomy headlines weighs on sentiment towards Chinese equities as a whole, we are taking the view that much of the bad news has already been reflected in valuations. For example, following August’s selloff, news flow from China has remained negative, yet the market has since held up relatively well, suggesting that the bad news is very much in the price. In our view, the shakeout we saw during the third quarter has presented some very attractive stock-specific opportunities, particularly among innovative companies we believe have the potential to disrupt existing markets and industries; one example is freight services via mobile apps. So while favouring Chinese stocks may be counterintuitive to many investors, we take a more pragmatic approach, and see recent broad market weakness as an opportunity to add exposure to our favoured companies at what we see as very compelling levels.
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