Will AI be Skynet or Jarvis?

Movie aficionados will be familiar with Skynet from the movie series Terminator, an artificial intelligence (AI) system that decided to terminate humankind to preserve itself, when it gained self-awareness. On the opposite end of the spectrum is Jarvis, the witty AI assistant to Tony Stark (aka Ironman) in the Marvel Cinematic Universe, which helps Stark with everything including solving for time travel. Such movies paint multiple scenarios of the impact AI could have on our world. It is rather sobering to hear Geoffrey Hinton, a Nobel Prize winner known as the godfather of AI, talk about the need for AI to have maternal instincts: “If it’s not going to parent me, it’s going to replace me.”

While the need for regulation of AI development is a significant issue facing governments around the world, this article will focus on the more immediate issue of the investment implications from AI development.

Winner takes it all?

Large corporations and governments are already pouring billions into AI development today. The movies often depict one all-powerful AI entity, and many giant corporations today are racing to be this winner that takes it all. Indeed, we see in many technology developments, the network effect or the platform effect has led to the emergence of natural monopolies. With the network effect, a product or service becomes more valuable as more people use it, for instance social media. With the platform effect, a platform becomes more valuable as more users and developers engage with it, like app stores.

However, with AI development, it is currently not apparent that there will be one entity that rules them all. It appears more likely that pockets of expertise will develop within each industry or country (language). Many companies are investing in AI to keep up with the productivity enhancements offered or to keep up with the AI features being offered to customers. Much like regular competition, AI is becoming a tool to help gain a competitive edge.

The bottleneck

Arguably the bottleneck today lies with the tools needed to build an AI model – advanced semiconductor chips. These chips are used to “train” an AI model how to react based on an existing dataset, as well as to “infer” in real time how it should arrive at a question or situation based on its training. The most advanced chips can perform these computations faster, and they face excess demand as the supply chain cannot move fast enough to produce these chips. This is also the area of focus for the US government, as it controls the export of advanced semiconductors and semiconductor-making equipment, for national security reasons.

We are positive on the semiconductor industry as the growth opportunity remains immense, with AI development still in its early stages. The imposition of export or sales restrictions could mean bumps on the road, but we expect the semiconductor industry to continue to grow along its uptrend.

Beyond the semiconductor industry, we are positive on the broader technology sector in the US, Europe and China, where we expect the sector to outperform their respective markets. AI development is also creating huge demand for cloud infrastructure and it is powering data analytics for software companies on top of supporting software products and development.

Do the returns justify the investments?

A common pushback to AI development is that the benefits or returns could be disproportionately small, compared to the billions that are being poured in. Economic reality would eventually set in, goes the argument, where billions in AI investments will have to be written off.

However, while the benefits may not be fully apparent in the near term, the heavy investment in the billions are mostly undertaken today by the mega tech companies which generate significant free cashflows. These companies have the ability to invest in the most advanced chips and infrastructure to build their AI models. Investors are supportive of the investments as the underlying business for these tech companies continue to perform well, and AI is the major area that can make a difference for these large tech companies. Meanwhile, smaller companies would typically leverage off the AI models built by these giants.

An eye on valuation

The risk to AI development is a significant economic slowdown that affects the underlying business for these major tech companies: softer consumer demand for tech hardware and online entertainment, a reduction in corporate IT budgets, downturn in digital advertising and slowdown in ecommerce. These would impact the big tech companies’ cashflows, thus impacting their willingness to invest large amounts, creating a vicious cycle.

Although we are positive on the technology sector in the US, Europe and China, our preferred exposure now would be with the Hang Seng technology index. It offers a lower valuation, at 19x consensus 12-month forward price-earnings (PE) ratio, compared to 29x for the US technology sector and 25x for Europe’s technology sector. Estimated average earnings growth for the Hang Seng technology index is lower for the next two years at 14% versus 22% for US technology and 16% for Europe technology sectors. The composition of these three sectors is also different – notably, the most advanced chipmaker sits in the US and the most advanced semiconductor-equipment maker sits in Europe. China, however, has been demonstrating its ability to stay competitive in the AI race even without access to the most advanced chips. Following a strong run in the global equity market this year, we favour the lower valuation of the Hang Seng technology index, amongst the three regions.

More significantly for our world, we hope Jarvis, the witty assistant to Ironman, prevails over Skynet, the Terminator.

Disclaimer

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