UBS GWM says AI-driven rally ‘not a one-way street,’ but tech revenue should grow

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Investors’ AI enthusiasm has helped push technology stocks in the U.S. and abroad to new highs this year. The iShares MSCI AC World Information Technology Index, which tracks large- and mid-cap tech stocks in dozens of developed and developing markets, has risen more than 20% over the past 12 months. And locally, the vaunted Invesco QQQ Trust Series 1 ETF, which tracks large-cap U.S. tech stocks, is up nearly 40 percent over the same period.

The run of good form has been so dramatic that even a modest bump last week has Wall Street talking. A drop of just 1% in US tech stocks and a 2.1% drop in semiconductor shares led Solita Marcelli, Americas chief investment officer at UBS Global Wealth Management, to remind investors that corrections are natural. – the alleyway.”

The veteran market watcher noted that stronger-than-expected labor market data was weighing on tech shares after rising geopolitical tensions and changing forecasts of US interest rate cuts. Still, Marcelli said tech’s (very) recent underperformance hasn’t changed his positive view of AI-related stocks.

“With strong AI fundamentals, our expectations of 18% year-over-year earnings growth for global tech in 2024, and a 12-month forward price-to-earnings ratio of around 27x, we remain positive on global tech and companies. . Especially the AI ​​value chain,” he wrote in a note on Monday.

Evidence of higher demand, more products, and growing adoption

Marcelli cited three main reasons for his optimism on AI stocks: more “revolutionary” AI products to be launched soon, evidence of increased AI adoption, and broadening demand trends.

Ever since OpenAI released its chatbot ChatGPT to the world in November 2022, the tech sector has been racing to release new AI products. Generative AI has enabled the rise of text-to-video platforms like OpenAI’s Sora and text-to-music platforms like StabilityAI’s Audio 2.0, but AI is also being used in healthcare. to discover world-changing and potentially profitable new drugs, and has numerous new software engineering applications. Marcelli said the pace of innovation is so strong that she expects “more significant innovations like this in the next few quarters.”

The potential for new AI products will help drive demand for the technology. After being led by most big tech users last year, Marcelli said there are now “clear signs of AI demand becoming more mainstream.” It highlighted sovereigns including Sweden, Singapore, Sweden, Japan, Korea, and more as key sources of growing demand.

Erika Klauer, technology equity portfolio manager at Jennison Associates, an investment management firm with $194 billion in assets under management, echoed similar sentiments. He explained first. good fortune That governments around the world essentially want “their own version of ChatGPT, with their own language training… their own archives, their own cultural nuances,” and that means AI companies can take advantage of that. Many new expenses for

To his point, Larry Ellison, Oracle’s billionaire chairman and chief technology officer, revealed that his company is in talks with several countries and sovereign territories to run government applications on the cloud, including AI. “Almost every government wants an autonomous cloud,” Ellison said on a recent earnings call.

As for evidence of AI adoption, UBS’ Marcelli points to recent surveys that show a growing percentage of companies using AI. While only 5.4% of US companies were using AI as of the first quarter, according to the US Census Bureau’s Business Trends and Outlook Survey, this is still well above the 3.7% figure for the third quarter of 2023. And Marseille predicts this share will grow to 6.6%-12% over the next six months.

He also noted that the rate of adoption of AI in the technology sector is very high. In the Census Bureau’s information sector (NAICS 51), for example, 18% of companies said they used AI to develop goods or services in the first quarter. “We remain positive on the broader AI theme,” Marcelli concluded.

Biggest risk: A hawkish fade

While AI-related companies still have some tailwinds, there is a bigger threat on the horizon. A few months ago, investors believed the Federal Reserve would cut interest rates this summer. The prospect of lower borrowing costs has helped the stock market outperform this year, but several reports of expected inflation and some surprisingly strong labor market data recently have experts worried. It has been suggested that the Fed will not cut rates anytime soon. As Treasury Partners Chief Investment Officer Richard Saperstein said good fortune: “With low unemployment, economic strength, and inflation above the Fed’s 2% target, it’s unlikely we’ll see a rate cut before July.”

If that happens, tech stocks, which are seen as high-risk assets and thus typically face pressure when rates rise, could suffer a pullback. And Saperstein warned that “with stock prices near record highs, earnings are burdened for further increases in stock prices.”

“Given the high market multiples and rising bond yields, we remain cautious on the stock until the earnings season provides clear evidence of earnings growth,” he added.

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