Big Tech Earnings Reveal Cracks in Case for Massive AI Spending
“We’re starting to see, in some cases, a discipline check that investors are putting on companies.”
(Bloomberg) — A week that saw the Federal Reserve cut interest rates and dozens of US companies report earnings nevertheless boiled down to a single theme: artificial intelligence.
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Results from US technology giants showed that the world’s biggest corporations are still pouring billions into AI infrastructure, cheering investors and bolstering the case for betting on the technology. The S&P 500 Index and Nasdaq 100 both advanced for the week and are hovering near fresh records.
Yet traders were also quick to punish companies whose expenditures weren’t showing enough of a near-term reward — a shift in the once-relentless optimism around AI spending. Worries over massive outlays at Facebook-parent Meta Platforms Inc. sent the company’s shares on their biggest daily drop in three years. Microsoft Corp. fell more than 4% in two days after revenue growth in its cloud-computing business failed to impress investors.
“We’re starting to see, in some cases, a discipline check that investors are putting on companies,” said Kevin Gordon, head of macro research and strategy at Charles Schwab & Co. “At some point we will have to have some proof about what return can come from this investment.”
By contrast, investors were more sanguine about big spending at Amazon.com Inc. and Alphabet Inc. Accelerating growth at Amazon Web Services helped send the company’s stock up nearly 10% on Friday, despite a big jump in capital expenditures. Google-parent Alphabet rallied 2.5% on Thursday, fueled by surging demand for its cloud and AI services.
Here are four key things we learned this week.
Revenue Growth
AI spending alone is unlikely to satisfy investors, who are now laser-focused on revenue growth.
Take the contrasting reactions to Big Tech earnings over the past week: Alphabet and Amazon executives pledged to pour more money into AI infrastructure but also demonstrated how past outlays were already showing results.
Alphabet said third-quarter revenue from products built on its generative AI models more than tripled from a year ago, while Google Cloud sales expanded about 34% to $15.2 billion, beating analyst estimates.
Meanwhile, Amazon reassured investors with robust cloud growth, while Chief Executive Officer Andy Jassy revealed new details on AI-related ventures, including expectations that its shopping chatbot will help drive an additional $10 billion in annual sales.
Meta — which doesn’t have a cloud computing business to show off AI-fueled revenue growth — found it harder to placate Wall Street’s spending worries, even as CEO Mark Zuckerberg touted AI-related improvements in ad-targeting and engagement and made a case for building excess capacity.
“This is the first quarter we’ve seen where more capex wasn’t uniformly rewarded,” said Allen Bond, portfolio manager at Jensen Investment Management. “There’s more focus on return on invested capital.”
Green Light
That said, many investors saw the commitments from the industry’s biggest spenders as a green light for the sweeping AI trade that has galvanized broad swaths of the market this year, from semiconductors to electricity providers.
Perhaps the most obvious beneficiary has been Nvidia Corp., whose chips dominate the market for AI computing. Its shares surged almost 9% this week, making it the first company to reach a market value of $5 trillion.
There were plenty of other AI-related gainers. Strong forecasts boosted shares of Seagate Technology Holdings Inc. and Western Digital Corp. Server manufacturer Super Micro Computer Inc. and chipmaker Broadcom Inc. each rose more than 4% for the week. Even Caterpillar Inc., the heavy-duty machinery company that’s benefiting from a boom in data center construction, jumped 10%.
Shares of Apple Inc., which spends less on AI than other megacaps, rose around 2.9% for the week despite mixed earnings.
Earnings Beats
Big Tech companies as a whole delivered earnings growth that outpaced Wall Street estimates, providing a measure of comfort for investors who had grown nervous over a richly valued stock market.
With earnings reports now in from six of the so-called Magnificent Seven, which also includes Tesla Inc., quarterly profit growth is tracking at about 27% for the group, compared with the 15% expansion anticipated before the reporting season started, according to data compiled by Bloomberg Intelligence.
The S&P 500, by contrast, is on pace for 13% earnings growth, with results in from more than half of the benchmark’s constituents.
“Tech estimates were rising ahead of these results, and they’re still beating the higher bar,” said Schwab’s Gordon. “That’s a very healthy support for the market.”
Final Boss
While this week’s earnings reports provided a lot to like for the AI trade, investors will have to wait three more weeks to hear from what is the industry’s biggest bellwether — Nvidia.
The maker of graphics processing units used in AI computing is scheduled to report on Nov. 19 and expectations are high — especially after Chief Executive Officer Jensen Huang gave a strong outlook for growth at an event in Washington D.C. this week. Given the company’s central role in the industry, any disappointments in its results could ripple widely.
For now, however, investors are enjoying the ride.
“Earnings were expected to be good and big tech delivered,” said Bob Savage, head of markets macro strategy at BNY. “It is hard to be bearish on a sector that makes money so consistently.”
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