Ausbiz: Looking beyond the AI anxiety and market concentration

What I know is that investors are getting very anxious now about where we sit in this AI cycle, because definitively returns have been really strong. Fundamentals and earnings are there. But what we know so far this year is that 80% plus of the total global equity index return has been driven by AI stocks. And you can fill now with, you mentioned some results last night. Micron down 10%. Meta makes an announcement kind of up 8%. These daily moves are quite unusual. And it just shows that investors are investing into the dream and hope of AI being great in the future. But the moment something changes, the moment we get a little bit disappointed, you see quite extreme price moves. And to me that just shows we're investing in something we don't know about. So there's going to be a lot more volatility. And that's what I think investors have to realize the stage of the cycle we're in now.

How do you play that then if it's an unknown isn't it.

Yeah. Well the challenge here for investors is the rest of the market is really it's growing but it's lackluster growth. So the opportunity cost of not being invested in something you mentioned Sandisk up 750%. Investors have this fear of missing out. And what we're also seeing is that investors also say, well this is almost a sure thing. The narrative is AI is amazing, AI will continue to change the world and spending will continue. So leverage and a lot of these levered ETFs are really starting to increase. And some of that is actually a little bit worrying but increasing volatility.

How do you play that. To be succinct, I think we are now more concerned about the companies spending the money, spending the free cash flow, starting to lever up their balance sheets to invest in all this infrastructure and capacity in AI. But what we know, at least in the here and now, is that money will continue to benefit a lot of the infrastructure hardware players in the space.

What about that market concentration? How much of a concern is that and that does that? Then as an investor, if you're looking to invest in the market, you need to broaden your outlook. It's not just Wall Street. I mean, you take a look. Korea for instance, just a couple of stocks which has thrown that market so high.

Yeah. Absolutely. So if you were to look at market concentration levels, we are now twice as concentrated as we were ten years earlier. So for the global index now 25% of the index is in just ten stocks. For the US index it's around 40% of that index is just in ten stocks. That concentration grows as the big AI beneficiaries are better and better and better. But if we can agree that there is more hope being placed upon an unknown future for how AI is monetized, then investors now are not getting diversification in an index. In fact, they are going to be quite heavily concentrated and exposed more than any other period of markets, to a point where those cracks start to fall. The big issue for us is those ten stocks I'm talking about have now transitioned from really durable, steady compounders that were capital light to now potentially steady compounders in the future, but are now capital heavy businesses. So the return on invested capital and the free cash flow measures we look at. Fundamentally, we think they look like less healthy businesses going forward.

Okay. So this then we're that position, Sam, where this is the advantage of having an active strategy rather than passive and following an index.

It feels like the market backdrop, we can call it a regime or something else is shifting. And if that regime is shifting, investors need to think about if that future of what the market wants to reward is different. If, I mean, God forbid, the market starts to focus on what we now call boring businesses, businesses that just benefit from the consumer or from manufacturing start to actually be in vogue again. That's something that investors are heavily underexposed to today. So it's one thing that I think the opportunity set will be broader. And investors are not going to get that in passive strategies. But it's also if we start to see cracks, not just in the AI trade but in the economy. And if this cycle is closer to ending whatever cracks it, whether it's inflation or another war oil or something like that, there's been a few concerns along the way, the impact and the volatility investors are going to feel now and passive is going to be much greater than it has been in the past. But the distinct difference here is passive will not change. So where active is going to offer investors something that they should think more about in the future is if that market regime is changing, you are locking yourself in passive effectively to the AI trade, when the market might be much broader and about something else in the future.

So, Sam, beyond the AI trade, where are you seeing the opportunity?

Right now it's in industrials. It's a little bit in financials. It's actually in some physical asset harder businesses. So areas of cost materials. We actually still think despite the moves and oil price poster potential resolution because it's not resolved yet. Um offer a lot more not just inflation protection but exposure to a supply chain that's going to have to retool in a world where energy security is much more important. So I think that while AI is becoming more physical asset heavy in a sector that was quite capital lite and about operating leverage of cloud and software and things like that. We're actually investing a little bit more in physical asset heavy parts of the market, but away from tech. So materials, utilities, a little bit of real estate are examples there.

All right. I mean, you talk about, um, I guess the infrastructure assets which are in vogue. So you see a lot of potential there then.

Uh, infrastructure in a different way. So infrastructure is, is actually our exposure to tech, where we're actually leaning more away from those mega stocks, driving the index more towards where they're spending the money. So within AI infrastructure and even you might not expect it, but AI is actually starting to dominate other sectors like industrials now that are supplying the infrastructure.

Well case in point being caterpillar for instance how well that stock's done because well it's not just earthmoving equipment. It's supplying data centers now too.

Yeah. So we own caterpillar and that's a that's a perfect example. They are selling effectively gas generators or diesel generators that are powering data centers. Because as the hyperscalers build a new, um, data center, they don't have enough capacity from the grid. So it's sort of bring your generators that were used in mines out in, you know, very remote places.