Shifting Artificial Intelligence leadership is an opportunity

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In this article, Russ Koesterich discusses why the recent shift in technology and AI-related leadership could prove to be an investment opportunity. 

Key takeaways

• 2024 equity market performance was driven by AI related growth, particularly in the semiconductor space. While still a core growth segment, recent news around the ability to build infrastructure more efficiently led to a shift in market leadership.
• Going forward, investors may want to consider expanding their exposure to areas that stand to benefit from the AI rollout and have room to grow earnings.

Last year’s stock market performance, particularly the artificial intelligence (AI) space, resembled a train barreling straight down the tracks at top speed; so far this year has been more of a rollercoaster. Investors have been contending with high valuations, lofty expectations, and a shift in the narrative following the announcement from Chinese AI software company, Deep Seek, in late January. That said, for all the twists and turns, AI remains a potent, multi-year, if not decade, driver of both markets and the broader economy. For investors, the key is to stay invested while considering the potential for a shift in leadership as things evolve.

Since the initial news surrounding Open AI’s Chat GPT, semiconductor stocks have been the big winners, up roughly 150%. And within semis, the undisputed leader of the space has been NVIDIA (NVDA), up roughly 750%! Not only are NVDA’s sophisticated GPU (graphics processing unit) chips critical to the AI process, but the company has benefited from a capital spending arms race. Microsoft, Alphabet and Meta have announced 2025 AI related capital spending plans of respectively $80 billion, $75 billion and $65 billion.

Adding to the frenzy, AI training and queries require significantly more power than traditional internet searches. As a result, there has been a rush to guarantee sufficient energy, including restarting moth-balled nuclear power plants. In addition to semiconductor companies, investors have been chasing this trend as well.

Shift in Power?

While massive capital investment in AI infrastructure is almost certain to continue, Deep Seek’s (seeming) success in building a competitive engine for considerably less, suggests the possibility of cheaper and more abundant AI. While semiconductor and power companies initially plunged on the news, many tech companies that provide AI apps surged. To my mind this makes sense.

Shifting market leadership also reflects another issue: valuations. Last year’s winners are some of the market’s most expensive stocks. For example, semiconductor stocks geared to AI spending are trading at roughly 2x the market’s multiple.

As investors take a pause on some of last year’s leaders, other companies will take the baton. Potential winners include software, social media, and entertainment companies, many of which stand to also benefit from still robust consumer spending.

One sector that includes many of these companies is communication services, which includes both social media and entertainment. The sector is experiencing a surge in upward revisions to expected earnings (see Chart 1).

Chart 1

Global sector earnings momentum
Change in 12m forward earnings estimates (MSCI World Sectors)

While it seems like AI has dominated the news forever, it is still the very early days, with the full significance and potential of the technology quickly evolving. Investors will want to remain invested in this theme. While still maintaining some exposure to last year’s winners, I would also be adding to companies that stand to benefit if the AI rollout proves to be faster and cheaper than previously expected.

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The Morningstar Rating^TM for funds, or "star rating", is calculated for managed products (including mutual funds, variable annuity and variable life subaccounts, exchange-traded funds, closed-end funds, and separate accounts) with at least a three-year history. Exchange-traded funds and open-ended mutual funds are considered a single population for comparative purposes. It is calculated based on a Morningstar Risk-Adjusted Return measure (excluding any applicable sales charges) that accounts for variation in a managed product's monthly excess performance, placing more emphasis on downward variations and rewarding consistent performance. The top 10% of products in each product category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars, and the bottom 10% receive 1 star. The Overall Morningstar Rating for a managed product is derived from a weighted average of the performance figures associated with its three-, five-, and 10-year 60-119 months of total returns, and 50% 10-year rating/30% five-year rating/20% three-year rating for 120 or more months of total returns. While the 10-year overall star rating formula seems to give the most weight to the 10-year period, the most recent three-year period actually has the greatest impact because it is included in all three rating periods. 

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