AI trade now dominates global portfolios, leaving investors exposed
Investor portfolios have become alarmingly reliant on the fortunes of the AI trade, which now spans stocks, real estate, infrastructure and energy, says Katie Martin for the Financial Times. The S&P 500 hit a record last week, but stripped of AI, the index has fallen 7 per cent since end-August.
LONDON: The AI trade is no longer a new theme but has morphed into “the” theme - a vast, suffocating blob slathered on top of the global financial system, starving everything else of oxygen and leaving every portfolio, everywhere, alarmingly reliant on the fortunes of just one bet, says Katie Martin for the Financial Times.
Stocks, real estate, infrastructure, energy, emerging markets, and some vintages of private equity are all, to a large extent, the same trade. The sheer dominance of AI over global stocks was on emphatic display last week. The oil price continued to smoulder at US$100 or so a barrel, with traders warning that logistical constraints in the Strait of Hormuz opened up a very real chance of a push to US$200. Bond prices were stuck in the deepest rut in decades, with the 10-year benchmark US government bond yield wedged comfortably above 5 per cent.
Either or both of these things would usually pull stock markets lower. Instead, the S&P 500 index of US stocks hit a new record, as did the tech-heavy Nasdaq. Slicing up indices in weird and wonderful ways to suit a narrative is cheating, but it is needed to understand what is going on. If the AI component is stripped out of the S&P, the remaining rump has dropped by 7 per cent since the end of August.
The gap between the top-heavy typical index and its equal-weighted cousin has reached its widest point in nearly 24 years. Three-quarters of the stocks in the S&P fell last month, with tech stocks and the energy stocks that reflect the data centre build-out doing all the work. Professional investors are struggling to diversify properly, spooked by how correlated portfolios have become across supposedly diverse asset classes.
Non-US money has funnelled into dollar-denominated assets at an extraordinary pace over the past decade, and increasingly without currency hedging. The AI boom has almost by accident become a major prop not just for the US stock market but for the dollar too.
Private equity firm Bain said in a recent report that annual spending on AI infrastructure could reach US$1.5 trillion by 2031, but added that sustaining this level of investment would require an AI market approaching US$6 trillion annually - an industry worth one-and-a-half times the UK's entire annual economic output. Policymakers are also uncertain, with US Federal Reserve chair Kevin Warsh expecting AI-driven productivity to pull down inflation, while Mary Daly and Lisa Cook veer towards the view that the build-out poses an upward risk to inflation.
So we're left with a strikingly two-speed US stock market beloved of pretty much every investor on the planet, dominated by an AI build-out that is, in practical terms, nearly impossible to hedge or avoid. We don't really understand the long-term economic implications, but the underlying commercial assumptions seem rather heroic. And we've all, deliberately or otherwise, hitched our fortunes to the idea that it will work out just fine. We'd better be right.
