Investors question amount of spending in AI

Key Concepts

• Market Rotation: A shift in investment preference from one sector or asset class to another. Currently, a rotation away from software/tech and towards energy and materials.
• AI Capex: Capital expenditure related to Artificial Intelligence infrastructure (data centers, computing power, etc.). Concerns about the level of this expenditure are impacting markets.
• FOMC Minutes: Records of the Federal Open Market Committee meetings, providing insight into monetary policy decisions and future outlook.
• AI "Picks and Shovels": Companies providing the essential infrastructure (hardware, power, materials) for AI development, rather than the software applications themselves.
• AI Washing: Exaggerated or misleading claims about a company’s use of AI, similar to “greenwashing” in the ESG space.
• Moats: A company’s sustainable competitive advantage. AI disruption is threatening the moats of some software companies.

Market Rotation and Sector Performance

The discussion centers around a noticeable rotation in the market, moving away from software and technology stocks towards energy and materials. This shift is driven by concerns surrounding AI capital expenditure (capex) and a recalibration of investor preferences. US stocks have been “rocked this month by these concerns over AI capex and whatnot.” Traditional companies in industrials, financials, energy, and materials are gaining momentum due to their earnings reliability and insulation from AI-driven margin compression.

According to the Investment Manager Index, industrials, energy, and basic materials have climbed to the top of sector rankings, with industrials reaching the number one spot for the first time in six years. This rotation is expected to continue, supported by US administration investment in the industrial and defense sectors.

Caterpillar as a Case Study

Caterpillar is highlighted as a prime example of an industrial company benefiting from this shift. It’s not just benefiting from its traditional construction equipment business, but also from the demand generated by AI-driven infrastructure growth. Specifically, its construction equipment is essential for building new data centers, and its power and energy division supplies turbines and reciprocating engines needed for the redundancy of these facilities. Caterpillar’s shares have risen almost 20% in the past month, demonstrating the positive impact of this dynamic.

AI Economics: Winners and Losers

The conversation distinguishes between companies benefiting from AI and those incorporating AI. A key argument is that the initial “all-encompassing” AI narrative has given way to selectivity, revealing “winners and losers.”

Winners: Companies in the “picks and shovels” category – compute, semiconductors, and AI infrastructure – are thriving. AI demand for these players is visible, contractual, and front-loaded, tied to capacity buildout rather than end-user monetization. Enablers like power and natural gas companies are also performing well.

Losers: Software companies are facing pressure as AI disruption threatens their competitive advantages (“moats”). While essential software for critical applications will persist, investors are questioning long-term multiples. Examples cited include Cisco and Shopify, where investors have been “less impressed” with recent earnings despite growth.

The Risk of "AI Washing"

Terresa Shut warns of the potential for “AI washing,” where companies exaggerate their use of AI, similar to “greenwashing” in the ESG (Environmental, Social, and Governance) space. She emphasizes the need for clarity regarding which companies are genuinely leveraging AI to improve productivity, innovation, and margins.

Earnings Reactions and Macro Data

The discussion notes a shift in market focus towards micro-level earnings reports, with investors seemingly “shrugging off” macro data like jobs and inflation figures. This focus on company-specific performance is creating opportunities for stock selection.

The investment choices of Brishaw Haway are used as an example, highlighting a move away from tech giants like Apple and Amazon towards companies like The New York Times. Despite continued earnings beats and positive announcements from Nvidia, investors are becoming more pragmatic, scrutinizing the sustainability and source of earnings.

Framework for Evaluating AI Impact

The conversation implicitly outlines a framework for evaluating the impact of AI on companies:

1. Distinguish between enablers and direct AI players: Identify companies providing the infrastructure for AI versus those developing AI applications.
2. Assess revenue visibility: Prioritize companies with visible, contractual AI-related revenue streams.
3. Evaluate competitive advantages: Determine whether AI is strengthening or undermining a company’s existing “moats.”
4. Scrutinize earnings sustainability: Analyze the long-term viability of earnings growth, beyond short-term AI hype.

Notable Quotes

• Terresa Shut: “I think you know now we're finally starting to talk about the winners and the losers.” – Emphasizing the shift from broad AI enthusiasm to selective investment.
• Terresa Shut: “We’re seeing the market kind of sort the AI trade.” – Highlighting the market’s increasing discernment regarding AI investments.
• Terresa Shut: “There’s going to be a risk of kind of AI washing much as we saw with the ESG theme.” – Warning about misleading claims regarding AI adoption.

Synthesis/Conclusion

The interview reveals a significant shift in market dynamics, driven by a reassessment of AI’s economic impact. Investors are moving away from speculative software stocks towards companies providing the foundational infrastructure for AI and those with proven earnings reliability in traditional sectors like energy and materials. The key takeaway is the need for a pragmatic approach to AI investing, focusing on revenue visibility, sustainable competitive advantages, and a clear understanding of which companies are genuinely benefiting from the AI revolution versus simply leveraging the hype. Stock selection is now paramount, and investors are increasingly scrutinizing earnings sustainability and the underlying drivers of growth.