Earlier this week Morningstar analysts took the unusual step of downgrading the Morningstar Moat Rating on seven US listed and four Australian listed software shares. The moat rating signifies the ability of a company to hold competitors at bay through a sustainable competitive advantage. The reason for the downgrades – the threat of AI.
Technological advancements are the great unknown and throughout history they’ve upended long established competitive environments. The rapid pace of AI advancement has made the future for software companies less clear and this opacity has led our analysts to reassess their view on the continued dominance of long-established industry leaders.
A murky future and the resulting uncertainty has investors on edge and the impact is likely to persist far after the current concerns about the war against Iran are resolved.
AI's impact will be bigger than the personal computer
I graduated from university in 2001 and the computer and the internet have always been part of my work experience. It is hard for me to imagine work or a world without a computer and the internet.
Yet according to Joseph Davis, the global chief economist at Vanguard, the impact of AI will be far more profound than the personal computer and the internet. Davis acknowledges that isn’t the consensus view but believes most economists are being too conservate about the impact of AI.
“Our findings suggest that the continuation of the status quo, the basic expectation of most economists, is actually the least likely outcome,” Davis says. “We project that AI will have an even greater effect on productivity than the personal computer did. And we project that a scenario where AI transforms the economy is far more likely than one where AI disappoints.”
For all the attention that has been paid to AI since ChatGPT emerged in late 2022 Davis and the team and Vanguard believe AI is still early in the adoption and investment lifecycle. Vanguard believes that many industries are still ignoring AI and the percentage of work hours available for automation will double by 2028.
The increased adoption will be driven by continued investment. While the headline spend on the AI buildout is shocking, Vanguard provides historical context. Davis’ team compared the current share of total investment with other eras in the United States and found that there is more room to run for AI infrastructure spend.
What does this mean for investors?
For all the self-congratulatory chatter about changing the world, much of the innovation coming out of Silicon Valley lately didn’t meaningfully contribute to overall economic productivity. Social media, Uber and Netflix may have made our lives easier and made a lot of money for shareholders but that doesn’t mean the technology was economically transformative.
AI could be a very different story. Vanguard has deemed it a general-purpose technology. General purpose technologies like electricity or the railroads transform the entire economy – often with a significant amount of disruption to existing businesses and workforces. The disruption has gotten a good deal of press with proclamations of a ‘white-collar job apocalypse.’
What hasn’t gotten a lot of attention is the potential for widespread productivity improvements as AI adoption increases. The tech giants need this to happen to justify their spending and there will be continued debate about the extent of AI monetisation.
But if this general-purpose technology improves productivity maybe the real winners will be the boring companies who use AI to drive down costs. The beneficiary from the heavy spending on building out railroad networks was not the railroads themselves – it was the shippers. Same with electricity and fibre optic networks.
If the rate of adoption continues to expand, Vanguard believes many of the winners will be in more value-oriented sectors where efficiency gains will lead to higher earnings. These sectors include industrials, financials and select consumer segments.
Final thoughts
Once an emerging trend becomes universally accepted investors typically stick to linear thinking. It takes little intellectual horsepower, and it works as investors salivate at the prospects of limitless growth. Many of these investors – especially the ones that get in late – get burned.
Some investors will be able to pick out the winners in tech. By luck or skill, they will identify which of the mega-tech firms’ AI investments will pay off. They will pluck through the carnage of the software shares and find the companies who will withstand the competitive turbulence and continue to thrive. More power to them.
Given my situation I’m content to keep owning companies unlikely to be disrupted, but sure to benefit, from widespread AI adoption. I’m willing to trade lower upside for more safety. You may make a different decision. That is the crux of investing – a series of trade-offs that each of us has to make given our goals and circumstances.
For those interested in the full Vanguard report you can find it here.
Mark LaMonica
In this week's edition...
John Abernethy takes a sobering look at where Australia went wrong and what to do about it.
Noel Whittaker knows retirement planning is about far more than dollars and cents. He explains why the key to happiness in retirement is figuring out where you live.
Dark premonitions of mass white collar job losses fill the media. Nick Maggiulli has some suggestions to stand-out in the age of commoditized knowledge.
In honour of International Women’s Day, Annika Bradley has a simple solution to a set of challenges disproportionately facing women but also prevalent in the population as a whole – more financial advice.
Tony Dillon is back with a topic slightly less fun than the AFL. As inflation continues to creep higher and more economists forecast rate increases, Tony takes a look at the role energy policy plays on productivity and inflation.
The story has been the same for markets for years – US outperformance. Before Iran, a rotation was already underway as tech pulled back and other opportunities emerged. Franciso de Juan makes a compelling case for European small-caps.
One positive development for investors is the widespread acknowledgement that behavioural drivers impact decision making. Joe Wiggins explores at how individual behavioural drivers interact to create powerful feedback loops.
This week's white paper comes from Capital Group on China shifting its attention towards humanoid robotics as the next frontier for technological leadership.
Curated by Mark Lamonica and Leisa Bell
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