From the studio

վ:Paul Donovan on what next for the Fed(8 min)
Podcast:(18 min)

Thought of the day

The AI tech rally continues to power US equities to new highs, with Wednesday’s session led by gains in NVIDIA and other AI-aligned stocks. Recent weeks have brought more reasons for optimism. Dell doubled its growth estimates on AI demand, AMD announced a multi-year, multi-gigawatt chip deal with OpenAI, and OpenAI’s DevDay showcased new products and strategic partnerships with Samsung, SK Hynix, NVIDIA, Oracle, and Broadcom. TSMC reported a 30% year-on-year jump in third-quarter revenue on strong AI sales, while Bloomberg says the White House has approved several billion dollars of NVIDIA chip sales to the UAE.

Altogether, these deals point to hundreds of billions in investment commitments, reinforcing the sector’s rapid capital deployment and pace of innovation. At the same time, market concern over “circular investments” within AI companies and a potential AI-led stock market bubble has grown louder.

While we agree that the scale of the AI rally means volatility could pick up, and one should remain alert to signs of froth, we see several compelling reasons for investors to stay engaged with the AI theme:

Product innovation is continuing to drive compute demand. OpenAI’s latest DevDay announcements point to accelerating aggregate compute demand and deeper strategic partnership, in our view, and not an attempt to cannibalize other tech or commerce platforms. These strategic partnerships, such as OpenAI’s multi-year deals with AMD and NVIDIA, underscore the need for massive data center capacity, with up to 16 gigawatts of new infrastructure planned. We take the latest headlines as more evidence of cooperation and ecosystem building over competition, which should support broader adoption and incremental revenue opportunities.

AI adoption and monetization are still accelerating. AI adoption is growing rapidly. Notably, a new Microsoft survey from this year shows 26% of Americans US AI tools daily. Other markets are even higher, with 59% in fast adopters like the UAE and Singapore. This suggests significant upside for US economic productivity if enterprise and consumer adoption catches up, as we think is likely. One large language model provider recently launched the ability to both recommend and purchase products directly in its model, pointing to progress on monetization. We anticipate global AI revenues will grow at a 41% compound annual growth rate (CAGR) through 2030, reaching USD 2.6 trillion.

Valuations appear reasonable versus the dotcom era, and the total addressable market could be much larger. Despite outsized gains for key AI leaders, valuations are not yet at dotcom bubble extremes. For some large-cap tech names, the rapid pace of earnings growth has meant their price-to-earnings ratio has actually compressed over the past few years. While we understand concerns over potential AI froth, it’s important to note that today’s tech giants have higher-quality earnings, cash flows, and balance sheets than their 1990s counterparts. We also think the total addressable market for AI is potentially 11x larger than prior IT cycles.

So while the AI trade is not without its risks, we see compelling reasons to stay engaged. In our view, the rally remains underpinned by solid fundamentals, accelerating adoption, and a still-favorable macro environment. We continue to see global AI capex growing 67% year on year to USD 375bn this year and by a further 33% to USD 500bn next year, and we note that consensus forward estimates for capex have been surpassed threefold over the past two years. We recommend maintaining balanced exposure to AI-aligned companies across software, hardware, and semiconductors, with diversified positioning across enabling, intelligence, and application layers.

Investors should consider phasing in allocations on any market dips, and continue to focus on our Transformational Innovation Themes of Artificial intelligence, Power and resources, and Longevity. We also continue to favor China tech, backed by still-attractive valuations and robust medium-term earnings growth forecasts.