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Two things are going on right now that are (more or less) unrelated. First, Strait of Hormuz remains closed and oil is at post-war highs ($124 per barrel for Brent Crude compared to around $95 a couple of weeks ago). Second, AI progress continues to march on regardless. For March, the shock of the war dominated markets. In April, the expectation of some sort of messy deal meant the attention has switched back to the AI theme. And here we have seen one of the sharpest rallies in history for the US technology heavy Nasdaq Index outside of a recession:
Around six months ago, I wrote a piece here called Are we in an AI bubble? The concern (only 6 months ago!) was that we were over-investing in data centres in the same way we had over-invested in railways and fibre-optic cables in previous major booms. That isn’t the concern anymore. Instead, models continue to improve and they are (slowly) being brought into the workplace environment. For IPS, I think the impact has not been far off hiring an extra data analyst for maybe £1,500 or so a year. That is a great deal! Nearly all businesses would like to hire software and data analysts at those sort of rates. It looks pretty obvious to me we are going to need all those data centres.
And the huge investments needed for this are enough to keep profits growing. Around 40% of US earnings per share growth is expected to come from AI related investment spending alone:
Which has been driving a big pick up in forward looking profits:
If you are wondering how equities can rise even with oil twice the price it was 2 months ago, this is how. We have maintained our US exposure in part to keep exposure to the AI theme and this has definitely helped in April. But, as always, markets tend to lurch between extreme optimism and extreme pessimism. If this is extreme AI optimism, how best to diversify?
It is, of course, tempting to say emerging markets here. But there are a couple of problems with this. First, most Asian countries are energy importers and so are hardest hit by the ongoing energy shock (unlike the US which is an energy exporter these days). And second, much of the recent strength in emerging market equities has come from, you guessed it, AI related investment. It is worth remembering that many of the chips that power AI come from Taiwan Semiconductor (TSMC) and Korea. TSMC is by itself 14.6% of the MSCI Emerging Markets Index and Korea is 18.7%. Here are April month-to-date returns for these two and the broader Philadelphia Semiconductor Index:
The number one driver of recent emerging markets outperformance has been semiconductors. Emerging markets remain as geared to the ongoing AI boom as the US.
I put the lowly UK FTSE-All-Share index on the chart as well for comparison. Shell and BP mean it has some large winners if oil stays high. Also, its strength is its weakness: without much (any?) direct AI exposure in the index it is less vulnerable if and when the AI story starts to break. For those worried that everything runs in cycles, UK markets are probably as good a place to hide as any.
Chris Brown, CIO
cbrown@ipscap.com
The value of investments may fall as well as rise and you may not get back all capital invested. Past Performance is not a guide to future performance and should not be relied upon. Nothing in this market commentary should be read as or constitutes investment advice.
