News of an open-source artificial-intelligence (AI) model that could potentially rival current models at significantly lower cost caused tech shares to tumble recently, as investors began to question the value of the industry’s more established players.
Here, our global chief economist Joe Davis gives his perspective on current share prices, what the future might hold and AI’s potential to fundamentally change the economy.
What’s driving the dynamics in the tech sector?
Recent events are not entirely surprising. In areas of great innovation, there’s always potential for a start-up or new entrant to disrupt the status quo. This is particularly the case in the current environment, where US tech stocks have already soared in value in recent times. Despite impressive earnings, this provides little margin for error.
US share price valuations (a measure of how much investors are willing to pay for shares based on company earnings) are currently elevated. Much of this is due to the assumption that the leading tech firms will be able to continue to grow earnings by maintaining their competitive advantage.
But whether or not the new open-source AI proves to disrupt the existing AI ecosystem, it is a timely reminder of an enduring investment lesson: markets can underestimate the chance that dominant companies’ business models get disrupted by start-ups or economic changes.
There’s certainly plenty of precedent for this, especially in times of transformational technological change. For instance, between 1900 and 1908, nearly 500 automobile companies came into existence, but more than half also disappeared. Today, only two of them are still around. That’s typical of the creative destruction you see as new entrants wipe away the value of older companies.
According to Stanford University’s annual AI Report, there have been 5,500 AI-related public and private companies launched in the past 10 years in the US alone – that’s greater than the total number of publicly listed US companies1. They can’t all be winners. And, if history is any guide, a few of them will surely be disruptors to today’s AI ecosystem as we know it.
Investors need to be aware of both the risks and opportunities, though the latter may not always be self-evident.
What are the hidden opportunities?
If AI is truly transformative, the biggest winners will likely be the beneficiaries of this technology, not necessarily the builders of the technology and its infrastructure, whose prices already reflect that optimism.
That said, I’m not suggesting that investors should abandon tech companies entirely. For most investors, it’s better to consider diversifying by owning shares across a whole range of industries.
As Vanguard’s founder, Jack Bogle, once said: “Don’t look for the needle in the haystack. Just buy the entire haystack.”
Different companies inevitably fall in and out of favour, but by owning them all you can potentially reap the benefits from those that are performing well, mitigating losses from those that aren’t.
Investors can also diversify by spreading their money across different types of investments, such as shares and bonds2. As we said in our economic and market outlook for 2025, the outlook for bonds is positive. This may strengthen the case for adding bonds to investment portfolios because they can help to balance out any ups and downs in other investments such as shares.
The bottom line is to consider building and maintaining a balanced portfolio that reflects your goals and attitude to risk, and staying the course when markets dip.
1 See https://aiindex.stanford.edu/wp-content/uploads/2024/05/HAI_AI-Index-Report-2024.pdf
2 Bonds are a type of loan issued by governments or companies, which typically pay a fixed amount of interest and return the capital at the end of the term. Once issued, bonds are traded, like shares, and their prices can fluctuate.
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