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Insights into the AI Rally
Last week, Unhedged checked out how virtually the entire gains within the S&P 500 since late March have come from AI and AI-related stocks. Below is a chart showing the dollar and percentage gains of Nvidia, the “Fab Five” Big Tech stocks (Alphabet, Amazon, Apple, Microsoft, Meta), and a basket of semiconductor stocks which have soared in anticipation of an AI-driven digital investment boom:
I find this a bit of concerning. A rising, historically expensive market that may easily fall if it weren't for a single investment theme could, in my view, turn right into a bear market if sentiment on that theme turns sour. For example, imagine if Nvidia were to lower its revenue forecast or certainly one of the Fab Five were to chop its capital spending budget.
Expectations are clearly high for AI stocks, however it's probably value getting a bit of more specific here. Consensus estimates for revenue growth next yr and for 2026 actually don't seem overly ambitious. Analysts expect a 23 percent annual growth rate for Nvidia over that period. This would represent some moderation in the speed; over the past five years, Nvidia's revenue has grown 50 percent per yr. Likewise, the two-year revenue growth rates expected for the Fab Five are at or below growth rates in recent history. Only a handful of chip stocks — Micron, Texas Instruments, Analog, and Lam — are expected to see significant acceleration in revenue.
Is the AI group's recent surge because of earnings forecast increases? Looking on the 2025 estimates, probably not. Since the tip of March, earnings forecasts for all the group have increased by a low single-digit percentage. Apple, Amazon and Micron are the one ones which have received more significant increases.
What has radically modified within the AI rally is, not surprisingly, valuations. Over the past three months, the price-to-earnings ratios of Nvidia, Apple, Broadcom and Qualcomm have all risen by over 20 percent. Looking back to last October, when the rally began, the typical (harmonic mean) P/E of the AI group has risen by almost 50 percent.
That's lots. How should we interpret that? Maybe it just reflects momentum and animal spirits. Put more charitably, it would reflect an expectation that the AI business will proceed to generate increasing profits for a few years to return. In other words, it's a bet on the competitive dynamics inside the AI industry: that there can be no hyper-competition and that the winners in the long term can be the identical as today's winners – the Fab Five and today's market leaders within the semiconductor industry.
The second half of the bet, that incumbents will proceed to win, seems reasonable to me. Incumbents within the technology sector are very powerful, within the sense that corporations can leverage their strong market position in a single technology to construct a powerful position in one other (consider Microsoft's shift from PC operating systems to cloud computing). The first half of the bet, that AI won’t change into a capital-intensive knife fight where nobody makes big profits, is something I cannot comment on.
To assess the steadiness of the rally, we also must take a more in-depth take a look at how the non-AI stocks are performing. Here is how the S&P 500 sector performed after removing AI stocks:
The increase in capital spending by the 4 corporations between last fiscal yr and 2025 is $54 billion, which is greater than 40 percent of Nvidia's expected $100 billion increase in revenue. However, only a fraction of Big Tech's capital spending is prone to go toward Nvidia's GPUs. So either Big Tech will spend more or Nvidia will earn less. “We fear that either the technology sector's money flows or Nvidia's revenues are overestimated,” Cara writes.
It's possible that spending by other tech corporations at Nvidia will increase rapidly next yr, offsetting any shortfalls at the massive techs, but that may show how competitive the AI business could change into.
A superb read
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