AI Risks Will Widen Gap Between Chips, Software: Markets Pulse

s2umbhscfa3spwefiodq5lks_media_dl_1.png Bloomberg

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(Bloomberg) — A broad advance in technology stocks this earnings season will mask a growing divergence between software and hardware names, the latest Markets Pulse survey shows.

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Of 122 respondents to a poll conducted April 24-28, 65% said the Bloomberg Magnificent Seven Index has room to run higher once the reporting period concludes. Yet participants were split over the magnitude of gains, as artificial intelligence developments drove a wedge between software service providers and companies that produce tangible technology assets. 

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The $58 billion VanEck Semiconductor ETF (SMH) has been on a tear since the start of 2023, including a 28% jump this month alone. Meanwhile, the $11.5 billion iShares Expanded Tech Software ETF (IGV) is coming off its worst quarter since the 2008 financial crisis. Chipmakers are outperforming software this year by their widest margin on record, based on the ratio between the two funds. 

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“AI risk is a real risk,” Ted Koenig, Monroe Capital Chairman & CEO, said in a Bloomberg Television interview this week. “Software that is more commoditized, where it can be developed easily and there’s low switching costs, that’s all at risk. You’re going to see those companies get hurt.”

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Monroe’s Koenig: AI Will Make Select Software Better (Video)

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Capex Focus

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Some of the biggest technology companies will report results on Wednesday, and investors will be focusing on their AI spending plans. A $1 trillion capital expenditure boom over the next 12 months is expected to ripple out beyond tech into energy infrastructure, according to Bloomberg Intelligence data. 

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More than half of survey participants disagreed or strongly disagreed that companies’ AI expenditures are justified by the returns. That said, the share of those who agreed in this month’s survey — at 41% — was greater than the 38% who answered similarly in an October poll.

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“We believe that this AI buildout has years to go on the power of the related sales and earnings growth alone,” said JoAnne Feeney, portfolio manager and partner at Advisors Capital Management. “These stocks should continue to climb.”

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Rising Costs

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Elevated input costs for both physical components and energy led the list of risk factors survey participants expect to be the most-cited risk factor for tech companies in the current reporting period. 

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Chipmaking in particular demands a huge supply of energy, spurring concern that producers would have to curtail output as costs rise. Yet even with WTI crude prices up about 48% since the onset of war in Iran, tech stock gains have cushioned the broader US equity market. 

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What Bloomberg strategists say…

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“WTI oil prices above $100 have historically marked challenging regimes for risk assets, but the strength of the AI cycle is lending equities unusual resilience this time around.”

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— Tatiana Darie, Macro Strategist, Markets Live. For the full analysis, click here. 

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—With assistance from Romaine Bostick and Carmen Reinicke.

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