Ausbiz: AI is driving markets, but investors are rethinking where to own it

Well, it's remained on Wall Street and what we're seeing there with AI remaining the driver there, but increasing concerns around spending later to broader rotations and sharper swings.

To break it down, we are joined by Sam Ruiz from T. Rowe Price. Sam, welcome back to you.

Good morning, Andrew.

I was just asking you before you came on the show, how, how has your month been?

So you feel as though you're sort of getting ahead of the market at the moment?

Yeah, I mean, you’re effectively alluded to it.

There's only two things that matter right now.

It's how you play the AI trade that is driving everything, not just earnings, but economic growth and it's how you hedge inflation.

So what are you expecting comes from Iran, whether it's resolution or not?

I think that our positioning at the moment is reflecting that we need to have a little bit more sort of commodities in the portfolio to hedge that inflation risk.

But we've successfully transitioned to where we think the better opportunity in AI is right now.

And that's away from the company's spending on AI and it's more towards the companies that are receiving those dollars from those spenders.

All right. Because when we take a look at that AI CapEx, it remains watering, eye watering, doesn't it?

Because in fact, I was just talking about this with our previous guest in terms of that at least CapEx, PIMCO analyst, they're coming up.

They reckon that CapEx will absorb 94% of hyperscalers operating cash flows over the next two years.

Yeah, and that is the concern for us. So these hyperscalers have great businesses.

Why have they been so good over the last 15 years as companies, really strong free cash flow, really big net cash balance sheets and they've been able to recycle that free cash flow into high recurring revenues and profits.

Now there's this concern and this is really our view, it's something we debate a lot actually, is we think that the hyperscalers will continue to spend money whether they can monetize this successfully or not. And why is that?

Because it's now a competitive and defence imperative that if they don't spend the money, someone else is going to compete and take their share.

That means that the CapEx numbers, we think, stay stronger for longer, but it's at the cost of those companies spending money and reducing free cash flow and potentially now going out to the market and raising debt and raising equity.

Increasing leverage makes the quality of those businesses potentially a little lower, while the question marks around how they monetize it continue to grow.

Yeah, In fact, big tech new debt issuance now already around close to 1 1/2 billion dollars.

What you're saying is they're going to continue spending until what point?

So a number of things. So these hyperscaler businesses are really dependent on economic growth.

They get their revenue, they get their demand from areas like digital advertising and they have to receive that revenue to be able to recycle that free cash flow into the CapEx.

Well, it's not really free cash flow that's going into CapEx.

The other thing is what we call scaling laws.

So there's a there's models, we sort of think of Claude's model, open AI's model.

And right now, for every incremental dollar that's spent on training those models, the models are getting better.

If that stops, we realize we've reached the peak, then there's no incentive to spend as much money to keep training new models.

The other thing is that's really important is to see continued monetization of these models.

So what is, I just believe, truly staggering?

If you think of Anthropic, they really had no revenue in 2024.

They now look like they're going to exit this year at potentially $100 billion annual run rate of revenue.

This is a company with no revenue two years ago that's now going to have more revenue than the biggest sort of enterprise software player like Salesforce.

If any of those things slow down or stop, that is going to put a bump in the road in terms of whether these companies are incentivised to spend more.

All right.

So how you change your portfolio?

Actually, I'm just going to correct myself too, because I said I've missed the decimal point on that amount of new debt issue.

It's 135 billion this year so far.

How are you shifting your portfolio then as a result if you're concerned about that spin?

Yeah. So our, if you were to call it MAG 7, it's not really a MAG 7 anymore. It's more like a MAG 10.

We have reduced our weight to those companies.

Right now. We are more incrementally overweight.

Some of the hardware players now there's a couple of transitions here that are playing out.

It's the spenders on AI with great stocks and that's sort of already started to filter through to who's receiving those dollars.

But what we're realizing is there were sort of key suppliers such as NVIDIA that were in the box seat to receive that money because they effectively had a monopoly on the GPU or the cheap or what's needed.

What we're realizing now is that this CapEx that is being spent is such an enormous tidal wave of money to the point where this sort of even in the last few weeks, we've seen some of the CEOs of some of those largest companies in the US.

And they've told us that they would have spent even more than the surprising figures they announced if they could get access to more of the components, whether it's the connectors that are going in, whether it's the memory that's effectively going into the data centers.

What that means now is you know that more money is likely to come for the next two years.

But also, you might have said two years ago, we're only going to buy chips off of NVIDIA.

They're the best.

Now you're like, they can't give us enough.

We're going to filter to a second best.

So I'll give you a great example.

We actually really like a company called AMD.

AMD does not have as good of the GPU as NVIDIA, but if you can't get enough GPUs from NVIDIA, you're more likely to now go down to the next best and go acquire that from someone like an AMD.

That's the sort of thing that we're starting to figure out.

Companies that didn't have the likely expansion of growth are actually coming ahead of us now.

Sam, what about the space trade you're getting on that?

Space trade is a really interesting one. We were there. We've actually already opted out.

So in our portfolio we owned SpaceX privately, we actually bought it closer to a $30 billion $40 billion valuation and exited around 400 billion, which looks a little light now given that we're going to see it come on in, in mid June around 1 1/2 trillion.

The concern for us is there is definitely an economic model there, but the valuation surrounding that seems quite excessive to us.

So that's one on IPO, we'd be more willing to sit out and just wait to see how the market assesses whether that valuation is something that the company can grow into or not.

What about the other forthcoming IPOs, Open AI, Anthropic?

Yeah.

So these are great companies.

The concern we have is not necessarily there's not much information yet around the valuations that are coming into the market.

It's these are going to be multi trillion dollar companies coming into the market at IPO, which is astounding, raising records level of, of capital.

We haven't seen this amount of issuance before.

And this is going to have to suck capital from somewhere else in the market.

So I, I mentioned that we're a little bit more conservative around some of these MAG 7 type mega cap tech stocks because fundamentals are potentially weakening.

There's also going to be a trade here where investors and big funds need to say, well, if I'm going to have to own these stocks because they're going into the index.

And a little side point here, these IPOs don't normally get into the index day one.

Normally they have to have a number of quarters of showing financials before they make the cut.

It's likely we might see these come into the indexes immediately and that money has to come from somewhere, most likely the mega cap tech stocks.

Sam, what do you think is the greatest motivator at the moment on Wall Street?

Is it that the fear of missing out on this, on the AI boom, or is it the fear of losing looking back to the dot com bubble and thinking, hang on, we've been here before?

Yeah, I, I think it's a little bit of everything.

The one thing I'd really emphasize is a lot of this rally has actually been supported by really strong fundamentals.

So if we looked at the last earnings that just came out of the US market, call it Wall Street or whatever you will, this was one of the biggest upgrades and surprises to expectations.

We saw year over year earnings growth of 28%, which is enormous for the US market.

And it's no surprise following that we had a couple of the best months in April that we've seen in 20/25 years for various US indexes that are out there.

There is a bit of retail participation here, some speculation, a lot of leverage creep.

If you look at margin lending levels, they're actually the highest they've almost ever been, which are a little bit worrying to us.

And that speculation is it's a really important distinction.

We think there's an AI opportunity, but we're really trying to focus where we're invested with companies.

We think we'll have the cash flow are profitable today where the margins have a little bit more duration into the future and aren't something that's you know really profitable today, maybe loss making in two years time.