HAMISH MCRAE: Investors present wholesome skepticism on AI

It is called the Great Rotation, and it was happening in earnest last week. 

What it describes is the shift by investors away from the high-tech giants of the US, especially those reckoned most likely to benefit from artificial intelligence, and towards companies in basic industries on less ambitious price to earning ratios.

On Wednesday, the Nasdaq index of high-tech corporations fell by 3.6 per cent, its worst day since October 2022.

While the two most valuable of the lot, Apple and Microsoft, are still worth well over $3 trillion (£2.3 trillion), Nvidia, the one seen as the greatest beneficiary of the generative AI revolution, has slipped below that elevated benchmark. The market recovered a bit on Friday, but it has been a nasty week.

Two things seem to be happening. One is that a change in the mood of investors which everyone knew would take place sooner or later – from the hope of growth to the reality of the need for profits – seems now to have begun.

Looking to the future: In the AI revolution there will be losers as well as winners

The other is that it is becoming clear that applying AI successfully in practical ways is going to be expensive, complex and unpredictable, so it is not at all clear who will make money out of it.

The first theme is a familiar one. There is always a tension between growth and value. If you go for growth you accept a low annual return in the hope the increase in capital value will more than compensate. 

If you prefer value, you bank fairly high dividends accepting you will never make your fortune from soaring share values.

It is a choice that people make for all sorts of reasons – their age, temperament, need for dividends and so on. But the harsh truth is that for the past decade growth has won.

Portfolios of fast-growing firms have achieved higher total returns than the high-dividend plodders, and because the US market is dominated by the high-tech giants it has risen faster than the UK and European ones.

Those of us expecting a shift of sentiment towards value have so far been proved wrong. But we also know from history that all bubbles burst, so the question vexing investors on both sides of the Atlantic is whether the jitters of the past few days are harbingers of a wider reassessment of investment strategy.

Maybe this is a start of a period when value investing comes back into fashion.

As for the AI revolution, it is pretty clear this will bring huge increases in the performance of the service industries. That is already starting. But the problems are also becoming evident.

One is the energy demand from the massive computing power that AI requires to function. There are stories of coal-fired generating plants having to be brought back online to keep the AI servers running.

Another is the capital investment needed to train and develop the models so that they can be reliable and useful.

Then there is how to apply it in practical ways. How do you save money by using AI instead of people, and what do you do when you find the quality of your service has fallen because you have got rid of the wrong staff? There are many troubling privacy issues.

It is always like this at the early stages of a technological revolution. We know that the apparent beneficiaries may actually not do nearly as well as seemed likely, and the real winners may not yet exist.

We saw all that with the dotcom bubble that burst at the beginning of this century and, though the hyperbole now is less extreme, that episode remains a warning for us all.

Actually, I think what has happened in the past few days is extremely healthy. It is always sensible for investors to question whether one strategy that worked very well – in this case backing big tech America – may have run its course.

And it is healthy in a more specific sense that we should be sensitive to the downsides of AI as well as its potential.

I think it is the Holy Grail that will transform the productivity of the service industries, but as in all revolutions there will be losers as well as winners, and let’s be frank about that, too.