- We believe AI has the potential to significantly alter both the economic and investment landscape. The headline contribution to activity so far largely reflects capacity build-out rather than broad-based productivity improvements. Unsurprisingly, AI-related investment has been overwhelmingly dominated by the US, followed with a large gap by China. This concentration means the immediate boost to real GDP is primarily investment-led and geographically uneven.
- Recent industry surveys already show a significant pick-up in AI adoption in the US and in China with pockets of efficiency gains, but by and large companies remain in the early innings of AI adoption. Translating capital spending into sustained output-per-worker gains is typically a multi-year process that requires diffusion, reskilling and complementary investment.
- Cross-country differences in AI capex, both in scale and composition, suggest that productivity paths may diverge over time. Economies with deeper innovation ecosystems, supportive regulation and strong digital infrastructure may be better positioned to capture efficiency gains, while others could see more modest impacts.
- From an investment perspective, so far, the sheer scale of AI-related capex has primarily supported stocks exposed to the infrastructure build-out. The process of AI adoption remains early, but large companies report more progress so far than smaller firms. We believe market focus will soon turn to AI-enablers and applications. With this in mind, we believe there is an attractive opportunity beyond the large US big tech companies as AI broadens out, particularly in the small cap space and EMs.
- More generally, we think it is important for investors to consider dedicated allocations to technology going forward given the acceleration and pace of the industry’s disruption, leading to potential wealth creation opportunities.
We are constructive on risk assets with a preference for equities as current credit spreads offer limited compression potential. We see stronger returns in EM equities driven by superior earnings growth and more attractive valuations. Even with fiscal concerns, we believe core fixed income can offer portfolio diversification given reduced inflation risk and steeper yield curves. Amid further monetary easing and healthy global growth, we expect the US dollar to decline modestly.
Upside scenario #1: Productivity boom
AI boosts productivity faster and further than expected, leading the global economy (led by the US) to experience a new era of rapid economic growth, potentially reaching levels not seen since the late 1990s.
Key Implications: Global tech surges, followed by EM equities. Inflation stays in check, a result of the disinflationary impact from enhanced productivity. This allows for higher revisions in economic potential growth, which in turn keeps long-duration bond yields elevated.
Upside scenario #2: Russia/Ukraine ceasefire
Energy prices fall with the recovery in Ukrainian production capacity and potential removal of sanctions on Russia, while European growth accelerates via higher real income and improved consumer and business confidence.
Key Implications: European (DM and EM) equities rally on the back of a valuation boost and higher expected earnings from the reconstruction of Ukraine. Given the extent of the reconstruction job, European credit and financials may also benefit, as well as infrastructure.
Downside scenario #1: AI disappointment
Tech capex is scaled down significantly as businesses question the viability of current AI expectations. The US economy slows as corporates scale back investment and the stock market sells off, creating negative wealth effect and prompting higher-income consumers to slow spending.
Key Implications: Global equities experience a correction while defensive sectors, such as Healthcare, and high-dividend stocks stay more resilient. European equities outperform given lower exposure to the AI theme. Long-dated government bonds and liquid alternatives help reduce the overall portfolio drawdown.
Downside scenario #2: Germany letdown
The German government underdelivers on its infrastructure and defense budget, perhaps because of political divide, weighing on confidence. Germany grows below expectations, dragging down growth in the Euro area more broadly.
Key Implications: European domestically exposed stocks come under pressure as lower Euro area growth is priced in. European core fixed income provides some buffer: duration rallies as more cuts by the ECB are discounted.
Source: am.gs.com
