Equity Perspective – Short term questions; long term opportunities intact

Summary

The start of 2025 brought hopes for a new leg to the Artificial Intelligence (AI) fueled Information Technology equity rally. However, at the end of January, news of DeepSeek’s development of a low-cost, open-sourced large language model appears to have created a near-term top for technology stocks. The macro uncertainty created by the tariff fed trade war and the technology export limitations to China have increased investor angst for stocks. We expect continued volatility around the AI trade as investors look for confirmation of continued robust spending. We remain steadfast in our belief AI spending will continue which will ultimately drive Information Technology stocks higher.

Our take 

On May 24, 2023, Nvidia ushered in the era of Artificial Intelligence with an earnings report that vastly exceeded expectations and with an outlook that was even more bullish. Ever since then, investors have focused on finding other beneficiaries of this modern-era gold rush. The initial spending came from the group commonly referred to as the hyperscalers. These are the companies operating massive-scale data centers providing cloud-based computer services. Amazon, Microsoft, Alphabet, and Meta are among this group. In 2023 and 2024, this group increased its spending by more than 50%, from around $140 billion in 2023 to $215 billion in 2024. Much of this spending was focused on Artificial Intelligence infrastructure. It is expected these companies will spend over $300 billion in 2025.

As is usually the case, investors quickly become accustomed to new trends and this growth in spending was no different. From July 2024 through the beginning of this year, many of the stocks of these AI companies entered a prolonged period of consolidation with few new buyers and few sellers. Investors were looking for other beneficiaries of AI spending and eagerly awaited any new use case of this emerging technology. Questions were starting to emerge about how quickly these companies will be able to earn a return on these massive investments.

The launch of DeepSeek’s AI model brought these questions to the forefront as it was developed at a dramatically lower cost than most thought possible, calling into question the spending that has occurred. While this created more volatility in the broader market, investors were starting to view DeepSeek in a more positive light as this demonstrated AI was scalable at a lower cost and use cases could expand.

However, last month investors were confronted with the prospects of a tariff induced trade war, higher inflation, and an uncertain economic outlook. With this, the S&P 500 has declined close to 10% with the Nasdaq 100 falling over 13% from their highs. This has investors asking if this AI fueled spending will come to an end and with it, the strong returns of the Nasdaq 100. We acknowledge it might take some time for the tech sector to regain market leadership and go to new highs. However, we remain steadfast in our belief spending on AI will continue to grow. If AI spend remains a priority, eventually the stocks will respond. We hesitate to put a specific timetable on this, instead urging investors to remain patient and opportunistic. So far, the tech sector relative earnings growth remains better than the broader market. We believe this demonstrates AI spending continues to be healthy.

While use cases remain in their infancy, evidence suggests this will not always be the case. Ultimately there could be countless applications for this technology, including some we cannot yet conceptualize. This isn’t to say the technology in its current form is not already compelling.

What makes AI so powerful is its ability to integrate and analyze data. Traditional data analysis was largely limited to what is called structured data. Examples of structured data include spreadsheets and databases. Sources that do not fit neatly in databases or spread sheets are called unstructured data. Organizations have mountains of unstructured data, which was difficult to access and/or use, even for the most organized companies. AI has changed this dynamic. We expect AI to make companies much more efficient in how they integrate and analyze data and enable them to make faster and quicker decisions. We expect this technology to drive efficiencies in manufacturing, robotics, and drug discovery. 

The long-term case is exciting. However, there is still reason to remain patient and opportunistic. Our base case is hyperscalers will continue to aggressively spend. Not only do they have the resources to do so, they also believe falling behind in AI capabilities is tantamount to becoming a dinosaur in today’s technology landscape. In fact, several hyperscalers have announced increased spending plans post DeepSeek.

Where we are focused is on enterprise and sovereign government spending. While corporations view technology spend as mission critical, it is subject to ebbs and flows from macro forces. The current tariff-induced trade wars could negatively impact GDP growth and with it, there is risk for corporate spending to be delayed. Tech valuations have improved but remain elevated. Cuts to earnings expectations could derail any near-term rally.

Ultimately, while hyperscalers will slow the growth rate of their AI spending, our expectation is their investment will remain elevated and we are still very early in enterprises deploying AI. Spending on technology can be delayed, but ultimately it is the lifeblood for success in today’s economy. For that reason, we believe the long-term opportunity is intact.

Bottom Line

We still expect Artificial Intelligence to drive performance of information technology stocks over the coming years. Near term, however, we believe the disconnect between the performance of the stocks involved in AI and the technology itself could continue. The introduction of tariffs as well as the debate over what semiconductor chips China should be able to access have introduced some uncertainty on both enterprise technology spending as well as sales and earnings growth for these companies. While valuations are certainly lower than they were at the beginning of the year, they remain elevated. Ultimately, we continue to believe we are in the early stages of AI investment and patient long-term investors will be rewarded as the market works through current growth concerns.