By Julian Howard (pictured), lead investment director, multi-asset solutions, GAM Investments
Pets.com, an internet company which sold pet food and supplies into the US retail market, was formed in 1998. A stellar rise saw the firm promoted during the 2000 Super Bowl and its advertising mascot was even interviewed on Good Morning America. Yet Pets.com was never profitable and it became totemic of the technology boom and bust of the turn of the century. By November 2000 it had ceased operations.
Referencing the advent of the SMS message, PayPal co-founder Peter Thiel famously lamented: “We wanted flying cars, instead we got 140 characters.”
The dot.com boom’s legacy is mixed to say the least. It appears to have had little lasting at impact on trend growth and productivity. In fact, by the early 2000s the concept of secular stagnation had taken hold in academic circles as a way of articulating the sluggish growth and low interest rates which were becoming characteristic of the economic landscape.
The 1990s tech boom therefore provides a cautionary tale on the nature of technological change and holds important lessons for how investors should approach the current artificial intelligence (AI) mania.
OpenAI’s founders declared in late May that “Within the next ten years, AI systems will exceed expert skill level in most domains and carry out as much productive activity as one of today’s largest corporations.” Similarly, Goldman Sachs believes that 300 million jobs could be lost, but that the reward for the associated increase in productivity will be a one-off increase in annual GDP of 7%.
But these predictions could be overstated. Investors today must therefore think about AI on two levels:
Impact on the economic outlook
Crucially for investors, growth and productivity did not always grow in the aftermath of previous so-called revolutions. The bond market is a good proxy for a ‘live’ view of future economic growth expectations today.
Adjusting the nominal yield on government bonds for inflation indicates what bond investors perceive to be future growth expectations. The results are an exceptionally bleak view of future growth across US, Japan, Germany and the UK and, importantly, one which has not meaningfully lifted as a result of the AI excitement.
This is important because it suggests that the most compelling organising thesis of future growth – secular stagnation – remains sadly intact.
If AI proves to be no different to previous technological revolutions in this regard, the existing challenges of worsening demographics, inequality and climate change will continue to weigh heavily on the global economy’s prospects.
Stock market valuations
This then leaves the issue of equity valuations, which appear to be pointing the other way. The US stock market has been on a tear since 30 November 2022 when OpenAI introduced the ChatGPT large language AI model to the world. From that date to 26 June of this year, the S&P 500 Index is up 7.1% and the Nasdaq 100 Index of technology stocks is up a stunning 22.7%. Valuations are therefore unsurprisingly stretched. Much of this advance has come from just seven stocks – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.
While many commentators are concerned at this lack of breadth, markets may not be wrong per se. Even if the so-called AI revolution does not profoundly change growth or productivity patterns, it seems likely that its adoption will be universally widespread.
Firms which enable the AI revolution may see significant earnings growth from, for example, renting computing processing power or distributing new AI-driven software applications across the economy.
Framing large cap technology firms as the ‘house’ rather than the ‘gambler’ in this way suggests that the rally in technology stocks could continue for longer as businesses of all kinds attempt to adopt AI into their working practices.
Beyond that, their prospects remain undimmed as a structural play that hedges against a dismal low growth scenario. Continuous innovation by technology firms can create earnings streams which outperform the bleak macroeconomic picture over time.
AI therefore poses a unique challenge to investors as it questions whether the latest technological breakthrough will be game-changing. But from the railways of the nineteenth century to the dot.com boom just over 100 years later, many technological hypes have proved less revolutionary than anticipated.
A sensible long-term investment strategy should focus on areas of the global stock market, including technology firms, that provide secular earnings growth in a low-growth world. There is no obvious reason now to revise this approach on the current evidence. For long-term investors, the AI story should just be one of many components of technological progress, achieved over the decades via a structural allocation to the asset class.
Whether AI represents a true revolution or, more likely, an evolution, should not really matter.
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