TechnologyHow AI can save the stock market

How AI can save the stock market

The surge of interest around artificial intelligence triggered by the sudden popularity of ChatGPT has generated trillions of dollars in market value.

Nvidia is the top stock mover so far this year, up more than 175% into the trillion dollar club, while Meta is also up 119%. Giants like Alphabet and Microsoft have posted returns close to 40%. All of this is happening as the US economy teeters toward recession and Congress is playing cash with the US debt ceiling.

It’s exactly what the stock market has needed to stay afloat as headwinds — including slowing earnings and high interest rates — have not stopped piling up. The S&P 500 has been basically flat since early April, and the rise of AI has helped offset multiple economic challenges.

This tug of war is indicative of a battle likely to unfold over the next decade. As negative forces combine to drag stocks lower, it is increasingly looking like AI may be the offsetting factor.

There are two fundamental elements at play: the increase in productivity that is supposed to drive widespread adoption of AI, and the resulting positive impact on profit margins, which are the main driver of stock gains.

AI is expected to increase productivity

The case for an AI-powered productivity boom is not just on the lips of stock market bulls. Academic researchers have also come to the same conclusion.

A recent study from Stanford and MIT found that workers at a Fortune 500 software company given generative AI tools were 14% more productive. Those gains were close to 30% for the least experienced workers.

“The system appears to create value by capturing and transmitting some of the organization’s tacit knowledge about solving problems and pleasing customers that was previously only learned through on-the-job experience,” reads a summary of the Institute’s report. Brookings.

Some of the world’s most prestigious investors and market experts also agree. Billionaire investor Paul Tudor Jones says the staggering popularity of AI has made him reevaluate his forecasts for inflation and the stock market.

“The introduction of great linguistic models [y] artificial intelligence are going to create a productivity boom that we’ve only seen a few times in the last 75 years,” Jones said in a recent interview at the CNBC.

Seasoned analyst Ed Yardeni, who was previously chief investment strategist at Oak Associates, Prudential Equity Group and Deutsche Bank, believes that AI-powered productivity may start a new extended bull cycle for stocks.

“This may be the event that kicks off the 2020s,” he blogged a couple of weeks ago. “If so, then we can spend a lot less time obsessing over what the Fed will do next and focus on how technology is boosting productivity and living standards across the economy.”

The crucial role of margin growth

To understand how this increased productivity will translate into stock earnings, one must first look at profit margins and the role they play in stock price appreciation. To do this, you have to go back decades.

Over the past 30 years or more, American companies have enjoyed immense profit margin growth. Since 1990, they have more than doubled.

That has been largely responsible for a rise of more than 1,100% in the S&P 500 during that period. After all, earnings growth has historically been the biggest driver of stock earnings, and margins are a reflection of how efficiently companies convert sales into real profits. And as the green line in the chart below shows, it’s not just the tech titans:

Goldman Sachs

But amid a general economic slowdown, margins have been trending lower and look set to fall further. Goldman Sachs believes margins have declined by one percentage point in recent quarters and forecasts a 36 basis point decline for the full year of 2023.

This decline is poised to hamper the ability of the S&P 500 to continue generating returns in line with its historical trend. This is because margin expansion has been the trump card of the market as revenue and GDP growth have slowed. Without that support, Goldman says shares will fall below their long-term average.

S&P 500 Real Total Return Index Level / S&P 500 Real Earnings Per Share (total return scale).

Goldman Sachs

The impact of AI on margins

This is where the AI ​​comes into play again and links everything together. According to Goldman, generative AI will boost US productivity growth by about 1.5 percentage points a year over a 10-year period. The firm expects this, in turn, to translate into a 4 percentage point increase in net profit margins for the S&P 500. This is basically pure space gas.

It’s basically pure fuel for stock returns, and could be what keeps the S&P 500 afloat when other positive catalysts evaporate. This chart shows the clear relationship between improved productivity growth and increased margins.

US annual productivity growth versus S&P 500 profit margin change.
US annual productivity growth versus S&P 500 profit margin change.

goldma sachs

As with any rapidly appreciating sector of the market, AI stocks are not without their detractors.

A recent Bank of America research note called this generation an “infant bubble,” noting that it started in easy-money conditions and is likely to end in an adjustment environment.

And while AI may end up being enormously powerful in the long run, the company notes that asset prices could still deflate significantly from current levels. After all, the rise of the Internet was technically a bubble.

Semantics aside, only time will tell if the AI ​​revolution will separate the winners who implement it from the losers who are affected by it. Be that as it may, it is undeniable that AI can become a key driver of the global market in the coming years.

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