We start the week with the markets as nervous as a long-tailed cat in a room full of rocking chairs. And Apple is at the core of several questions market participants have been grappling with this year.
While news broke on Saturday of Warren Buffett’s Berkshire Hathaway offloading about half its stake in Apple, a local sage, former top-rated Coronation fund manager Sunil Shah, was on my show earlier last week sharing his distaste for Apple and artificial intelligence (AI) mania a day before its second-quarter earnings.
Just two years ago the famously long-term focused Buffett referred to Apple as one of the four pillars of his portfolio, so a “rebalancing” this large reveals he may be calling a top in tech, growing doubt about the use case for AI and preparation for a recession in the US.
As these three interrelated themes are likely to drive market performance over the short to medium term, everyone is trying to formulate a view. Let’s start with calling a top in tech. Valuations have been difficult to justify. The difference between commodities and tech is a stark example.
Nvidia’s market cap is 22 times larger than that of BHP Billiton, yet it generates only 1.5 times more net income and holds 0.6 times more cash. This suggests mining cash flows are valued at just a 20th of tech cash flows, making them ex-growth from a production and pricing perspective.
However, for tech stocks to justify their valuations they require essential materials such as copper, which are in short supply and require big cost increases. Therefore, mining stocks are not ex-growth from a production and pricing perspective. Acquiring mining cash flows at a 20th of tech cash flows presents an incredible investment opportunity. This misallocation of capital is also being driven by the rise of passives, but that’s a column for another day.
Takes time
Much of the current tech momentum is built on AI mania. In this phase of hype it’s imperative for any leading tech company to be “in” on the AI race, just in case it turns out to be real in terms of revenue and profit potential. Shah says that every leading car brand is obligated to invest in full self-driving vehicles just in case it’s the future, leading to a capex war game. It’s this “fomo” that will sustain the sales of the picks and shovels of AI — Nvidia’s graphics processing units (GPUs). Nvidia can’t make enough GPUs to satisfy the frenzied fomo demand that spans every industry, even at 50% operating margins, a level unheard of in hardware.
Alphabet admitted it is not seeing adequate current return on invested capital on AI capex, is likely to be overinvesting, and struggled to provide concrete examples of killer apps deployed at scale, but emphasised that adoption of new technologies takes time, and the risks from overinvesting in AI are smaller than those from underinvesting.
The return on investment on this capex incurred in AI by industry is suspect. Shah points to a podcast with Massachusetts Institute of Technology professor Daron Acemoglu, who concludes that “just one in four AI tasks will be cost-effective in 10 years”.
Speaking on the Goldman Sachs Exchanges podcast, Acemoglu says despite big breakthroughs in AI, the impact won’t be seen for several years. That would mean AI will affect less than 5% of all tasks and boost US productivity by only 0.5% and GDP growth by 0.9% cumulatively over the next decade.
To get a return on the $1-trillion companies such as Nvidia, Microsoft, Alphabet, Amazon and Apple are expected to spend on AI capex in the next few years, AI will have to solve complex problems, Jim Covello, Goldman Sachs’ head of global equity research, said on the episode. “We’re a few years into this, and there’s not a single thing that this is being used for that’s cost-effective at this point,” he said.
Looming recession
As Shah said, there is no killer app yet. That’s a big leap of faith investors are taking on AI. It’s this new scepticism that has bumped tech into a market wobble. But there’s also an equally grave concern about a looming recession in the US that would dent its economic exceptionalism narrative amid stubbornly high inflation and rates.
The SAHM Rule recession indicator, which indicates a downturn when the unemployment rate rises 0.5 of a percentage point over a 12-month low, increased to 0.53 in July, indicating a looming recession in the US. This indicator has not given a false indication in the past 65 years, and each time it is broken the unemployment rate increases.
It does increasingly look like the Fed will again be caught flat-footed. That and the yen carry trade unwind unhinged markets last week.
Buffett also sold off some of his stock in Bank of America and Chinese electric vehicle maker BYD while doing very little buying. He is now sitting on nearly $277bn in cash, up from what was already a record $189bn last quarter.
What will Apple Intelligence do? Cook said: “It will be profound ...” But, wait a minute, he can’t name one additional function that will be added to the current app store. That doesn’t fill me with confidence in the valuation of 33 times forward price-earnings and a current five-year growth rate of 8%.
This is beginning to look very hairy.
• Avery, a financial journalist and broadcaster, produces BDTV’s ‘Business Watch’. Contact him at Badger@businesslive.co.za.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.