The Revolution That Wasn't

14 June 2024
Market Insights

The Revolution That Wasn't (at least not yet)

“We may not know where we are going, but we better know where we are.”
-Howard Marks

You don’t have to know how artificial intelligence works to know that it is changing the world. At least that’s what we are told daily. Here is a small sample of recent headlines pertaining to the AI Revolution:

The AI Revolution is Happening Now

- Forbes 8/21/2021

How the AI Revolution Will Reshape the World

- Time Magazine 9/1/2023

How Could AI Destroy Humanity?

- New York Times 6/10/23

These articles, and many more like them, talk about everything from the next industrial revolution to a Terminator-esque destruction of mankind as we know it. To be fair, the author of the NYT article, Cade Metz, seemed skeptical of the “Terminator end of the world scenario,” but simply highlighted the fact that many high-profile individuals in technology and artificial intelligence have raised such concerns. Needless to say, artificial intelligence is a big deal, and therefore it is important to think about how it will impact our lives and what it means from an economic and investment perspective.

An April 2023 article from Goldman Sachs Research titled "Generative AI could raise global GDP by 7%” offers some predictions as to what the future impact could be. Here are some of the key takeaways from that article:

“As tools using advances in natural language processing work their way into businesses andsociety, they could drive a 7% (or almost $7 trillion) increase in global GDP and liftproductivity growth by 1.5 percentage points over a 10-year period.
“Shifts in workflows triggered by these advances could expose the equivalent of 300 millionfull-time jobs (globally) to automation.
“Analyzing databases detailing the task content of over 900 occupations, our economistsestimate that roughly two-thirds of U.S. occupations are exposed to some degree of automationby AI. They further estimate that, of those occupations that are exposed, roughly a quarter toas much as half of their workload could be replaced.”
“Although the impact of AI on the labor market is likely to be significant, most jobs andindustries are only partially exposed to automation and are thus more likely to becomplemented rather than substituted.”

Per the excerpts above, Goldman Sachs Research is predicting a significant impact on labor productivity and economic growth. The researchers also believe that hundreds of millions of jobs globally could be impacted by AI in the coming years.

With such massive change afoot in the global economy, investors are wasting no time buying stocks in companies that are likely to benefit from the AI revolution. Some of the main attractions for stock investors include the cloud computing behemoths of Microsoft, Amazon, and Google. These companies are renting out the computing power in their data centers to software companies who want to leverage the power of artificial intelligence and large language models (LLMs). Apple had been left behind but has recently surged to the front of the AI boom as they announced several AI tools on June 10th that will be baked into the everyday operation of their newer phones. Utilities have had an unexpected boost resulting from the enormous demand on power from running and training the AI models. Last, but certainly not least, you have the semi-conductor companies led by Nvidia, which produce the sophisticated processors that are needed to run the models.

The impact of AI has been so powerful in the investment world that it is not at all controversial to state that the AI revolution saved the stock market in late 2022 from concerns of a slowing economy and declining share prices. Here are a couple of charts that reflect the tremendous stock price appreciation that has seemingly occurred on the back of the AI revolution over the last 15 – 20 months:

The first chart shows the growth in total dollar value for all stocks in the S&P 500 index since the beginning of 2023. The total value of S&P 500 stocks on 1/1/2023 was $32.13 trillion. The current value is just over $44 trillion dollars, meaning that the S&P 500 has added roughly $12 trillion dollars of value in the last 17 ½ months. To put that in context, the entire US economy is $28.4 trillion, and the entire European Union is ~ $15 trillion.

The second chart shows the increase in Nvidia (NVDA) stock over the same period. On January 1, 2023, NVDA was valued at $360 billion. Today, it is roughly $3,100 billion or $3.1 trillion which represents an increase of over 750%. The $2.7 trillion increase in value is roughly the size of France’s economy ($3.13 trillion)

The final chart compares the percentage growth in the total dollar value of the S&P 500 vs the percentage growth in the US economy. The economy began 2023 valued at $26.47 trillion. Today, it is roughly $28.42 trillion, representing nominal growth of 7.35%. The S&P 500 total dollar value growth has increased by 37.17% over the same period.

One of many things that we have a hard time wrapping our mind around in the world in which we live is, how can the value of the S&P 500 go up by almost 40% when the aggregate value of all goods and services produced by the US economy (GDP), which includes thousands of additional public and private businesses that are not represented in the S&P 500, only increase by 7%? It doesn’t make much sense on the surface. The excitement and promise of AI is that it will dramatically improve productivity. By definition, an increase in productivity (technology) results in an increase in the amount and quality of goods and services produced and ultimately creates a higher standard of living for everyone around the world. That is certainly what happened during the oft compared industrial revolution, and for the internet boom of the late 1990s.

Comparing the AI revolution to the internet boom of the 1990s interests us as we see many parallels. However, one area that differs is economic growth. We hear the AI cheerleaders on TV regularly compare 2024 to1996. It is “early innings” as they say. The implication is that stocks could go straight up for another four or five years. Let’s look at how the 1990s compared to today. Here is the annual real GDP growth in the late 1990s:

1996 = 3.8%
1997 = 4.4%
1998 = 4.5%
1999 = 4.8%
2000 = 4.1%

As you can see, economic growth was very strong during that period. Growth did not begin to slow until the 2nd half of 2000. The S&P 500 peaked in March of 2000 before falling 49% over the next two years.

Now let’s look at recent US GDP growth on the back of the AI revolution:

2022 = 1.9%
2023 = 2.5%
2024 (est) = 2.4%
2025 (est) = 1.8%
2026 (est) = 2.0%

Recent and projected future growth is running at roughly 50% of the rate we saw in the late 1990s. We have also seen a deceleration in the quarterly numbers coming off a very strong (possibly fiscally induced) 2023.

To help us make sense of the disparity between stock value growth and actual tangible economic results, let’s turn back to Goldman Sachs Research to review a recent article dated May 13, 2024. In an article titled, “AI is showing very positive signs of eventually boosting GDP and productivity” the team updates their forecast from a year ago. Here are some key takeaways:

“Until we’ve seen more significant uptake in the actual application of AI, in the regular workproduction process, I don’t think that we’re going to see as big of an impact on productivity. Thatbeing said, the early signs of future productivity gains look very, very positive.”
“We haven’t seen much of an impact on productivity growth so far. But the reason being is, eventhough we still see a lot of potential for AI to automate a lot of the things that workers do on a dayto-day basis, thereby saving a lot of time and generating large productivity gains, the adoptionrates are just fairly limited right now.”
“Some of the academic literature and economic studies that have looked at the increase inproductivity that we’ve seen following AI adoption, in a few specific cases, supports our view thatlarge productivity gains are possible. The average increase in productivity is about 25%.”
“No, it really hasn’t changed because our forecasts don’t assume any AI boost at all before 2027.And the very small increases in adoption that we’ve seen in the one year since we wrote our initialreport, I think, are consistent with our view that over the next three years AI is probably not goingto be a main driver of labor productivity and potential GDP growth.”
“We see about 5% of companies reporting that they do use generative AI today in regularproduction, but this is a fairly small share relative to the overall number of companies that wethink will ultimately benefit.”
“There have been some layoff announcements attributed to generative AI, but for the most part itseems like a very, very small share – less than 20,000 of all layoffs generated in the economy,which comes down to less than 0.1% of total job separations. So, AI hasn’t resulted in anysignificant job loss yet.”

Let’s review what we’ve learned so far. The S&P 500 has added $12 trillion in value, almost the equivalent of the Eurozone economic production, since the beginning of 2023. The strong market gains have come on the back of the AI revolution and led by the likes of Nvidia, Microsoft, Apple, Google and others which are commonly viewed as some of the main beneficiaries of AI. Despite the excitement, economic growth has stalled out at roughly half the rate that we saw during the internet boom in the late 1990s. While “academic studies” have shown the potential for a 25% increase in productivity from implementing generative AI, only 5% of the companies that they’ve surveyed are actually using it. While everyone knows that this technology is revolutionary, the future benefits will not BEGIN to accrue for at least three more years, and so far, there has been no impact on the job market.

This is not the story that you see on TV or read about online, but it certainly seems to be reality based on the macroeconomic numbers and the detailed research from firms like Goldman Sachs. We began this newsletter with one of our favorite quotes from investing legend, Howard Marks, in which he wrote, “We may not know where we are going, but we better have a good idea of where we are.” We can’t think of better advice for investors in today’s environment. Warren Buffett and his teacher / mentor, Ben Graham, often talked about investing in stocks like you were buying a real business. No businessman in his right mind would buy a business for 10x what it is worth today based on recent sales and earnings for the promise of explosive growth 3-5 years out into the future, yet that is what investors, both retail and institutional, are doing on a daily basis in the stock market. We don’t know what the future holds for AI stock investors, but it better be bright because “changing the world” is already priced in.

JPS Financial, LLC is registered as an investment adviser with the SEC. All information is believed to be current and should not be viewed as personalized investment advice. All expressions of opinion reflect the judgment of the authors on the date of publication and may change in response to market conditions. All investments and strategies have the potential for profit or loss

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