How AI is Revolutionizing the Marketplace for the Magnificent Seven

It has been a tough week for the Magnificent Seven, the group of technology stocks that have played a dominant role in the US stock market, buoyed by investor excitement about breakthroughs in artificial intelligence. As someone who closely follows the tech industry, I've watched with keen interest as these giants navigate the volatile landscape shaped by AI advancements.

Last year, Microsoft, Amazon, Apple, the chipmaker Nvidia, Google’s parent, Alphabet, Facebook’s owner, Meta, and Elon Musk’s Tesla accounted for half the gains in the S&P 500 share index. But in recent weeks, doubts about the return on AI investments, mixed quarterly results, shifting investor focus to other sectors, and weak US economic data have all taken a toll on these companies.

This all came to a head this week when the seven companies moved into correction territory, meaning their combined share prices have fallen more than 10% since their peak on July 10th. As an avid follower of market trends, I couldn't help but delve deeper into the reasons behind this shift and what it means for the future.

Why Have AI-Linked Stocks Suffered?

Primarily, there's a growing concern about whether the vast investments in AI by Microsoft, Google, and others will pay off. This concern has been simmering for months. Analysts at Goldman Sachs published a note in June with the title “Gen AI: too much spend, too little benefit?” The Wall Street bank questioned if the $1 trillion investment in AI over the next few years will “ever pay off.” Similarly, an analysis by Sequoia Capital, an early investor in ChatGPT developer OpenAI, estimated that tech companies would need to earn $600 billion to recoup their AI investments.

Zino confirmed that the Magnificent Seven had been hit hard by these concerns. “There is clearly some concern about the return on the AI investments they are making,” he said. However, he also noted that the big tech companies have been “doing a good job” of explaining their AI strategies in their most recent results.

Other factors at play include investor expectations that the US central bank, the Federal Reserve, may lower interest rates as soon as next month. The prospect of a drop in the cost of borrowing has buoyed investor support for companies that might benefit, such as smaller businesses, banks, and real estate firms. This is an example of “sector rotation,” where investors move their money into different areas of the stock market.

Concerns about the big seven have had a significant impact on the S&P 500, given that a handful of tech stocks make up so much of the index’s value. Henry Allen, a macro strategist at Deutsche Bank, pointed out, “Given the rising concentration of that group among US equities, that’s going to have an impact more broadly.” Fears about weakness in the US economy also hit global stock markets on Friday.

What Has Happened to Tech Stocks?

By Friday morning, the Magnificent Seven had fallen 11.8% from their peak last month. They have been in and out of correction territory—defined as a fall of 10% or more from recent highs—in recent weeks as doubts have spread. Quarterly results this week have been a mixed bag. Microsoft’s cloud computing division, which plays a key role in helping companies to train and operate AI models, reported lower-than-expected growth. Amazon, another big cloud computing player, also disappointed as growth at its cloud business was offset by higher spending on AI-related infrastructure such as data centers and chips.

However, there were bright spots. Meta’s shares rose on Thursday after strong revenue growth at the advertising-dependent Facebook and Instagram owner offset its commitment to spending heavily on AI. Apple sales also beat expectations on Thursday. Dan Coatsworth, an analyst at the investment platform AJ Bell, noted, “Expectations have arguably become too high for the so-called Magnificent Seven group of companies. Their success has made them untouchable in the eyes of investors, and when they fall short of greatness, out come the knives.”

A general sense that tech valuations may have become too high has also played a role. Angelo Zino, a technology analyst at CFRA Research, highlighted, “Valuations were getting to 20-year highs, and we were due for a pullback, as well as a pause to digest some of the gains we have seen over the past 18 months.”

On Friday, the Financial Times reported that hedge fund Elliott Management told investors in a note that AI was "overhyped" and Nvidia, which has been a huge beneficiary of the boom, is in a "bubble".

Should We Expect More AI Breakthroughs Over the Next 12 Months?

More breakthroughs are practically guaranteed, which may reassure investors. The largest companies in the field have clear roadmaps ahead, with training runs already in progress for the next generation of frontier models and new records being set practically every month. Just last week, the Alphabet-owned Google DeepMind announced a record performance by its systems on the International Maths Olympiad, a high-school level maths competition. This has observers wondering whether the company will be able to tackle long-unsolved problems in the near future.

The question for the research labs is whether the breakthroughs will be sufficiently revenue-generating to pay for the rapidly growing cost of their achievement. The bill for a frontier AI training run has increased tenfold every year since the AI boom took off in earnest, leaving even well-capitalized companies such as OpenAI, the Microsoft-backed startup behind ChatGPT, with question marks over how they finance such expenditure in the long run.

Is Generative AI Already Reaping Rewards for Companies Using It?

The most successful uses of generative AI—the term for AI tools that can create plausible text, audio, or images from simple prompts—in many companies have come from the bottom up. People have worked out how to effectively use tools such as Microsoft’s Copilot or Anthropic’s Claude to work more efficiently or cut out time-consuming tasks from their day altogether. But at a corporate level, there remain few stark success stories. Where Nvidia has got rich selling shovels in a gold rush, the best narrative from an AI user remains Klarna, the buy now, pay later company, which announced in February that its OpenAI-powered assistant handled two-thirds of its customer service requests in its first month.

Dario Maisto, a senior analyst at Forrester, pointed out that a lack of economically beneficial uses for generative AI is hampering the investment case. “There is still an issue of translating this technology into real, tangible economic benefit,” he said.

Navigating the ever-evolving landscape of AI and tech investments is no small feat. As we move forward, I’ll be keeping a close eye on how the Magnificent Seven adapt and innovate in response to these challenges. The future of AI holds immense potential, and it's fascinating to witness this transformative journey unfold in real time.