Big tech’s AI promises become a 'Show Me' story for investors
With six companies inside a group known as the Magnificent Seven already having reported, year-over-year earnings growth has slowed to nearly 30% in the second quarter, down from 50% in the prior period
After a jam-packed week of earnings reports from megacap technology companies one thing is clear: as profits slow, investors aren't impressed by artificial-intelligence promises anymore. They want to see results.
With six companies inside a group known as the Magnificent Seven already having reported, year-over-year earnings growth has slowed to nearly 30% in the second quarter, down from 50% in the prior period. Analysts expect that rate to decelerate further, to about 17% for those companies in the third quarter.
Results from Microsoft Corp., Meta Platforms Inc., Amazon.com Inc. and Apple Inc. this week signalled that the biggest companies in the world are still heavily investing in artificial intelligence. However, shares of Microsoft and Amazon slid after their reports because of fears that those AI investments aren't paying off for them — at least not yet — echoing the slip in Alphabet Inc.'s stock a week earlier.
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"Investors are entering a 'show me' phase, seeking concrete evidence of AI's impact on revenue and productivity," said Adam Sarhan, founder and chief executive officer at 50 Park Investments. "This is causing some scepticism and volatility."
Tesla Inc.'s July 24 report also disappointed investors, while Nvidia Corp. is due to release results later this month. The latest prints and commentary this week added to existing volatility.
Investors had already been shifting from large, trusted stocks into smaller, riskier parts of the market to lessen exposure to Big Tech. The earnings results, combined with the Federal Reserve signalling that a September rate cut may be on the table and a weaker-than-expected jobs report sent the Nasdaq 100 Index spiralling.
On Friday, the tech-heavy index closed down 11% from its July peak, entering a correction. Investors fled AI stocks and bid up bonds, sending Treasury yields lower.
The bond market is "telling us we're going to have to bring this sucker down real fast, and that's kind of worrying everybody," said Kim Forrest, chief investment officer at Bokeh Capital Partners. "Lower interest rates work for equities, except when it's being done in a hurry because things are bad."
Amazon's results, alongside reports from consumer names like McDonald's Corp. and Starbucks Corp. signalled a weakening US consumer, adding to concerns about a weaker macroeconomic backdrop, she said.
Investors were already concerned about hype-versus-reality in the tech sector, which contributed to sharp reactions when major companies underperformed, said Burns McKinney, managing director and senior portfolio manager at NFJ Investment Group.
"Some of the earnings results that have come in over the last couple of weeks have reminded investors that there's a lot of really high expectations baked into these valuations," he added.
There were some bright spots in the week that signalled the AI trade isn't completely dead.
Investors cheered Meta's results, including comments from Chief Executive Officer Mark Zuckerberg that signalled investments in AI helped drive targeted ad sales. Advanced Micro Devices Inc. spurred a Wednesday rally in chip stocks after it gave a rosy revenue forecast.
"Essentially what companies are saying is that they have to do this and if they don't, they could risk being irrelevant in the future," Gene Munster, managing partner of Deepwater Asset Management, said of the increased capital expenditures on artificial intelligence.
The sharp market reaction doesn't necessarily mean the AI trade is over, Sarhan said.
"Instead, it suggests a recalibration of expectations," he said. "We're seeing a shift from pure hype to a demand for tangible results."
