Tech's AI Hangover Is Just Getting Started

"One thing already seems certain about 2024: AI is going to need to start showing the money. Whether it can is a whole other question.

Excitement for generative artificial intelligence sparked by OpenAI's chatbot was the dominant theme for investors in 2023. The Nasdaq Composite jumped 43% for the year -- its second-best annual performance in 15 years. Technology and e-commerce companies on the S&P 500 averaged a gain of 57%, more than double the index's overall performance for the year.

But the new year might be ushering in more-sober perspectives. Tech stocks fell sharply on Tuesday and lost further ground on Wednesday, with some of the biggest gainers of 2023 registering the steepest drops. That includes chip makers Nvidia, Intel and Advanced Micro Devices along with software rivals including Salesforce, Adobe and ServiceNow. The megacap tech companies known as the Magnificent Seven averaged a loss of nearly 3% over the past two days, equating to a loss of more than $319 billion in combined market value.

Hangover from AI hype wasn't the sole culprit. Apple shares fell more than 3% on Tuesday after Tim Long of Barclays cut his rating to "sell," citing mostly lackluster demand for the latest iPhones.

But it is last year's big speculative run that added risk to the tech sector. Few companies aside from Nvidia are earning serious money on AI so far. Last year also saw many tech companies undergo significant layoffs and other restructuring moves as business slowed. Growth rates at the cloud-computing businesses of Amazon.com, Microsoft and Google all decelerated notably in 2023 compared with prior years, as major corporate customers undertook optimization efforts to trim their bills.

Still, stock prices at Amazon, Microsoft and Google parent Alphabet all surged during the year. Microsoft shares jumped 57% -- their best annual performance since 1999 -- to a record. The stock also ended the year at more than 33 times forward earnings, which is 18% above its five-year average, according to FactSet. Microsoft's close relationship with OpenAI and its aggressive adoption of ChatGPT-like functions into its products ranging from Word to PowerPoint to the Bing search engine have given the storied software company the perceived early lead in the AI race.

But Microsoft has a massive business throwing off more than $218 billion in annual revenue, against which AI will need to produce a lot of new growth to move the needle. And many of the company's large corporate customers are still figuring out how they want to use the technology, which could mean limited investment activity in the near term. In a survey of chief information officers last month, Brent Thill of Jefferies noted AI and machine learning "are not major drivers behind why customers intend to increase cloud spend." Bernstein analyst Toni Sacconaghi noted in a Dec. 19 report that "CIOs are generally still in the exploration phase on AI" after his own survey.

Adobe has shown what AI letdown can look like. Its stock price rose more than 85% for the year ahead of the company's fiscal fourth-quarter report last month, as investors had high hopes that Adobe's new generative AI tools would spark a surge in demand. But Adobe ended up using the report to project 10% revenue growth for the new fiscal year -- flat compared with the previous year's performance and a forecast that most analysts saw as conservative. The stock has fallen more than 8% since.

A similar turn in sentiment could haunt many of tech's fourth-quarter reports starting later this month. "We worry AI benefits may materialize later than many expect," Scotia Capital software analyst Patrick Colville wrote in a note to clients before the holiday break. In his own report around the same time, Alex Zukin of Wolfe Research wrote that "we are at peak AI hype with a likely slide into the trough of disillusionment, as actual GenAI revenue dollars take longer to materialize yielding at most low single digit upside to CY24 revenue estimates."

It might take a while for tech's expensive chatbots to prove they aren't just talk." [1]

1. Tech's AI Hangover Is Just Getting Started. Gallagher, Dan.  Wall Street Journal, Eastern edition; New York, N.Y.. 04 Jan 2024: B.12.