Doubts in AI Boom: Why Tech Giants Experience Slump?

Published Date: 3/08/2024

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The magnificent seven tech stocks have been hit by concerns over AI investment returns, mixed quarterly results, and sector rotation. "It's been a tough week for the magnificent seven, the group of technology stocks that has played a dominant role in the US stock market, buoyed by investor excitement about breakthroughs in artificial intelligence.

Last year, Microsoft, Amazon, Apple, the chipmaker Nvidia, Google’s parent, Alphabet, Facebook’s owner, Meta, and Elon Musk’s Tesla accounted for half the gains in the S&P 500 share index. But doubts about the return on AI investment, along with a mixed set of quarterly results, investors shifting their focus to other sectors, and weak US economic data have hit the group over the past month.

That came to a head this week when the seven companies moved into correction territory, meaning their combined share prices have fallen more than 10% since their peak on 10 July.

Primarily, there is concern about whether the vast investment in AI by Microsoft, Google, and others will pay off. This has been bubbling away in recent months. Analysts at Goldman Sachs published a note in June with the title “Gen AI  too much spend, too little benefit?” The Wall Street bank asked if a $1tn investment in AI over the next few years will “ever pay off”, while an analysis by Sequoia Capital, an early investor in ChatGPT developer OpenAI, estimated that tech companies will need to earn $600bn to pay back their AI investments.

Other factors at play include investor expectation that the US central bank, the Federal Reserve, may lower interest rates as soon as next month. The prospect of a drop in the cost of borrowing has buoyed investor support for companies that might benefit, such as smaller businesses, banks, and real estate firms.

Concerns about the big seven have had an impact on the S&P 500, given that a handful of tech stocks make up so much of the index’s value.

Quarterly results this week have been a mixed bag. Microsoft’s cloud computing division, which plays a key role in helping companies to train and operate AI models, reported lower-than-expected growth. Amazon, another big cloud computing player, also disappointed as growth at its cloud business was offset by higher spending on AI-related infrastructure such as datacentres and chips.

However, Meta’s shares rose on Thursday after strong revenue growth at the advertising-dependent Facebook and Instagram owner offset its commitment to spend heavily on AI. Apple sales also beat expectations on Thursday.

A general sense that tech valuations may have become too high has also played a role. Angelo Zino, a technology analyst at CFRA Research, says  “Valuations were getting to 20-year highs and we were due for a pullback, as well as a pause to digest some of the gains we have seen over the past 18 months.”

On Friday the Financial Times reported that hedge fund Elliott Management told investors in a note that AI was

FAQS:

Q: Why have AI-linked stocks suffered?

A: Primarily, there is concern about whether the vast investment in AI byMicrosoft, Google, and others will pay off.

Q: What has happened to tech stocks this week?

A: The seven companies moved into correction territory, meaning their combined share prices have fallen more than 10% since their peak on 10 July.

Q: Should we expect more AI breakthroughs over the next 12 months?

A: More breakthroughs are practically guaranteed, which may reassure investors.

Q: Is generative AI already reaping rewards for companies using it?

A: The most successful uses of generative AI have come from the bottom up: people who have worked out how to effectively use tools such as Microsoft’s Copilot or Anthropic’s Claude to work more efficiently, or cut out time-consuming tasks from their day altogether.

Q: What is the main issue hampering the investment case for generative AI?

A: A lack of economically beneficial uses for generative AI is hampering the investment case.

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