Early signs of the AI apocalypse?

AI apocalypse: Pacman eating a city — P4NP7C Original Film Title: PIXELS. English Title: PIXELS. Film Director: CHRIS COLUMBUS. Year: 2015. Credit: COLUMBIA PICTURES / Album

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Since at least the summer of last year, a large part of the financial commentariat has been waiting for the bubble in US AI stocks to burst.

Instead, something stranger is unfolding. In recent weeks, some leading technology names have suffered heavy sell-offs (Microsoft and Amazon are both off 17% since late January).

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Software firms – first victims of the AI apocalypse

Those seeking to understand the success of US tech over the past 15 years need only consider the economics of software.

While developing a software product can be expensive, the marginal cost of shipping extra units is virtually zero. This makes software as a service (SaaS) ludicrously profitable.

Last year, Microsoft boasted gross margins of 68%. For comparison, supermarket Tesco’s gross margin is about 7%.

In 2011, venture capitalist Marc Andreessen declared that “software is eating the world”. Now AI is threatening to eat software.

On 5 February, start-up Anthropic launched the latest edition of its Claude Opus chatbot.

Highly capable at coding, it had been used to create a professional platform that performs basic legal analysis.

The implication is clear. If AI tools allow companies to create their own enterprise software in-house, why would they need to keep paying top dollar for a team of Silicon Valley software engineers to do it for them?

A major sell-off followed – dubbed the “Saaspocalypse”. The S&P North American Technology Software index has lost 30% of its value since the start of October.

Amplified by debt concerns, the world’s most profitable business model suddenly looks like one of the riskiest.

London’s small club of data-led firms wasn’t spared.

Everything from logistics to wealth management sold off as investors searched for new AI victims.

Yet despite the rout, the wider US market is flat for the year. Why? First, not all tech is in the doghouse.

Google is thought to have an AI edge because of all its data.

Hardware suppliers such as SanDisk and Western Digital remain in hot demand.

Second, some old-economy stocks are enjoying a lift.

Energy and commodity firms stand to gain from the data-centre build-out.

Industrials might be better positioned to pocket the gains of AI than the tech firms themselves.

Supported by the tailwind of an ageing population, healthcare is growing at a solid clip. If the rotation trend holds, then the FTSE, which is infamous for its “dinosaurs”, might just be set for a revival.

Yet uncertainty is rife. It will be a long time before we get a clear idea of the real winners and losers from AI disruption, says Jim Reid of Deutsche Bank. “That leaves plenty of room for investors’ imaginations… to run wild.”

Expect a volatile year with lots of “big sentiment swings” ahead. As for investors, remember that, “as with all disruption, opportunities will abound”.

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Alex is an investment writer who has been contributing to MoneyWeek since 2015. He has been the magazine’s markets editor since 2019.

Alex has a passion for demystifying the often arcane world of finance for a general readership. While financial media tends to focus compulsively on the latest trend, the best opportunities can lie forgotten elsewhere.

He is especially interested in European equities – where his fluent French helps him to cover the continent’s largest bourse – and emerging markets, where his experience living in Beijing, and conversational Chinese, prove useful.

Hailing from Leeds, he studied Philosophy, Politics and Economics at the University of Oxford. He also holds a Master of Public Health from the University of Manchester.