The mega-cap tech stocks that have driven the market this year are officially stalling. Since the second week of July, the stocks of the Magnificent Seven, from Amazon.com Inc. to Tesla Inc., have been losing altitude like rockets running out of fuel.
And it got even worse last week. Alphabet reported slowing revenue growth at its YouTube business. Falling electric vehicle prices and deliveries hurt Tesla’s earnings. The Mag7’s trajectory took another downward turn.
One reason for the decline in stock prices is a shift by investors from big technology companies to small and mid-cap stocks. The technology-led Nasdaq Composite Index began to fall against the Russell 2000 Index around July 10. Wall Street analysts took advantage of the Russell’s surge to dig up overlooked small and mid-cap names.
But no single factor explains the market’s movements, and the Russell’s smaller stocks can’t soak up all the money from the larger stocks.The divergence in the fortunes of the two indexes has only tracked the Nasdaq’s several months this year when it outperformed the Russell and the S&P 500.
Another explanation for the change in sentiment is that investors are worried that spending on artificial intelligence may slow.
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Big tech companies have wowed the world with their new generative AI platforms. For most tech companies, that has meant huge spending on AI chips. Nvidia, the leading vendor of those chips, is benefiting the most. Everyone is cheering as Amazon, Apple, and other big players release their AI chips.
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Alphabet’s Google Metaplatform
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and Microsoft are spending tens of billions of dollars each on AI data centers.
gen-AI models can write computer code and compose music, but they have yet to generate significant revenue for any company outside of Nvidia and a few other hardware vendors.
It’s only natural for investors to ask what kind of return they can expect from these billion-dollar capital investments. I posed this question in May but didn’t get a clear answer.
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When we queried the AI model itself, the first result ominously listed job cuts.
As a journalist, I don’t like to take credit for ideas. Some have wondered about the return on investment in AI. In June, Sequoia Capital venture capitalist David Kahn updated an influential analysis first published last year that estimated that Nvidia’s customers would need to increase AI revenue by $600 billion to see an acceptable return on their investment. At this point, Kahn thinks the company would be lucky to get $100 billion in new revenue across its customers.
Kahn agrees that AI will transform the economy, just as the internet and railroads did before it, and Sequoia has backed AI startups. But he adds that many speculators who invested in earlier technologies went bankrupt when early valuations collapsed, benefiting everyone who uses rail or internet services.
Two weeks ago, when Meta’s stock was struggling, Morgan Stanley analyst Brian Nowak also looked at what sort of return on investment Facebook’s parent company could expect from the $45 billion in capital expenditures it plans to make this year and in 2025. Concluding that AI will boost engagement on Facebook and Instagram, Nowak maintained his buy recommendation on Meta.
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The point of this column is not to say that the Mag 7 sale represents a better pricing of the benefits companies will get from their AI investments. No one can say with precision what those predictions will be, just as early investors could not have predicted how railroad cities would develop or how social media would emerge from the internet.
I’m actually making the opposite argument: if anyone sold stocks because they believed AI investments would slow, they’re not listening to the people who are spending: Big tech companies will continue to buy AI hardware from Nvidia and other vendors.
As Alphabet released its fourth-quarter report last week showing that capital spending nearly doubled from the same period a year ago, CEO Sundar Pichai told investors the company needed to get ahead and invest aggressively in AI, which is expected to transform all of its core businesses, from search to YouTube to cloud computing.
“When you go through a curve like this, the risk of underinvesting for us is much greater than the risk of overinvesting,” he said.
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It’s not just internet companies. Nouber Afeyan, a co-founder of Moderna, recently told me about biotech startup Flagship Pioneering’s plans to invest some of the billions it recently raised in AI models for drug discovery. “We don’t know if it’s going to work,” he said. “Are we just going to sit back and get someone to think about whether it’s going to work? No.”
No one can predict who will win the AI sweepstakes in the long run, but in the short term you’d better trust that the money will keep flowing.
Write Bill Alpert william.alpert@barrons.com
