The Winner Take All Mentality In “AI”

The fact that many companies' actual businesses are not benefiting from the expected boom in AI feeds into the related point: just how concentrated this boom in investment in artificial intelligence has been.

It is becoming very apparent from this season's earning that there are winners - Nvidia, Meta, Google, Microsoft etc. - but they are few and far between.

The narrowness of the stock market out-performers is reflected in the fact that the Big 5 are once again over 30% of the S&P 500.

That is for a good reason:

AI profits are powering ahead. Here is the key chart:

Which shows that the big 5 companies (no longer the "Magnificent 7," as we have argued but rather a "Fab 4/5") continue to see their profits revised higher while the rest of the index is actually negative thus far this year.

In other words, a handful of companies are finding their profits going far, far above the guidance and expectations. The rest of the index is finding they are disappointing the same forward guidance.

The Big AI winners are not just making more money, however but also possibly cannibalizing revenues and profits from elsewhere in the tech economy.

As Nvidia's and Microsoft's profits power ahead and other software and hardware company profits languish these suspicions only grow.

This is zero sum therefore. Nvidia's gain is someone else's loss.

The money for AI investment and experimentation has to come from somewhere and, as this quarter's earnings make clear, it is coming from elsewhere in the tech sector.

Investors are reallocating accordingly.

Every Nvidia GPU purchased or Microsoft Azure cloud computing contract is another potential loss elsewhere in the tech "stack" or sector. Companies are doing "AI or" not "AI and." That is a key difference.

This brings us to our third and perhaps most surprising and least appreciated point:

It is remarkable how sober and disciplined the AI boom has been.

You wouldn't know this to look at Nvidia's stock price (or order book) but that is a function of their monopolistic position in a very crucial niche and, evidently, isn't

Overall, the numbers. For instance, Pitchbook points out that in all of 2023 venture capital invested over $27 billion in AI startups. That is significant but not otherworldly. The same industry invested over $33 billion in crypto and blockchain startups in 2021 alone.

The cost of AI is also prohibitively more than these other areas.

When it comes to the actual economy - not venture capital - the numbers are even lower. Some estimates have Gen AI spending at around 1% of global technology budgets or around ~$30 billion a year. Yes, it is growing very quickly but from a low, low base.

The volume thus doesn't come anywhere close to matching the numbers of the previous tech booms such as the switch to mobile, cloud computing or the original internet stock mania.

Put it all together and what does it all mean?

It leaves us feeling somewhat optimistic about all the AI! Most corporations and investors are keeping their heads and thinking strategically and also carefully.

A sober and step-by-step approach may be less sexy and even underwhelming but it also has a far better track record than the "believe the hype" approach beloved by Youtube personalities, power boat salesmen and real estate agents in the Bay Area.

The downside is that the impact on the real economy will also be muted, at least for now.

This could be bad for software company stocks but it could be a good thing. Unlike, say, "Web3" or "Blockchain" or "5G" we could actually take the time and care to make sure our investment pay off down the road. Companies are being strategic and sober in how and where they invest. That is a bit boring but might be a great sign, including for investors. Less of a sugar high perhaps, but also less of a crash after.

This doesn't mean that Nvidia's shares can't fall. To the contrary, they easily can especially when some companies may be simply stockpiling their products for the future rather than needing them productively. But it also suggests that the real economy is neither dependent on the AI boom nor is it vulnerable to a reverse.

Previously we have made the case that Nvidia was making real profits from selling real (and very expensive) chips. This was different from the likes of (or WeWork for that matter). The question at these levels of the share price is not "is it real" but rather "can it continue"?


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