Beyond the Hype: Are Market Participants Underestimating the Role of AI?

[Zacks | Our Research. Your Success.] WeekendWisdom Tactics that Work in Good Markets and Bad [Bryan Hayes - Editor] Beyond the Hype: Are Market Participants Underestimating the Role of AI? By: Bryan Hayes Saturday, September 2 --------------------------------------------------------------- The major market indexes have regained much of the ground lost last year. Yet this year's incredible stock market rally continues to be one of the most hated in recent memory, as the naysayers remain doubtful that the momentum can continue. And to some degree, their reasoning is understandable. Bears point to numerous problems in the current landscape, such as the failure of several large regional banks earlier this year, along with recent U.S. government and domestic bank ratings downgrades from major agencies like Fitch and Moody's. These issues have certainly increased investor anxiety, and the reality is that they likely aren't fully behind us. But financial markets have a way of hinting at what may come in the future. The fact of the matter is this – markets are not screaming that something drastic and systemic is currently underway, as they have an uncanny ability to look past the noise. As the saying goes, stocks climb a wall of worry. I believe these widely-discussed issues pale in comparison to the theme that has driven the bullish equity rally this year. Artificial intelligence (AI) has come to the forefront recently, but the movement has been decades in the making. We've seen major strides over the last 15 years in particular, starting with the technology that powers our smartphones. There have been other clear milestones along the way, including the beginnings of autonomous driving. Still, we've heard from several notable investment managers and analysts in recent months stating that the AI hype has caused related tech stocks to become overvalued, and that this recent run-up is not justified. I think they have it backwards. I'm of the opinion that we are literally in the infancy stage of this AI revolution. AI Will Undoubtedly Boost Productivity In recent years, the global economy has experienced a disparity between the availability of skilled workers and robust demand for goods and services. The gap has driven both wages and inflation higher. From a historical perspective, major technological advancements have helped to automate tasks, which in turn makes existing workers more productive. Thus, AI should help drive down inflation over time and increase corporate earnings. We're just beginning to scratch the surface with new digital technologies like generative AI models, which use neural networks to identify patterns and structures within existing data to generate new content. Generative AI applications such as ChatGPT have been all the rage this year. These new tools have captured the imaginations of people around the world. And as these applications continue to be updated to newer versions, we're only now just beginning to witness the range of tasks that can be completed such as their ability to write text and code, create digital art, and enable new levels of voice and music generation. These AI advancements have the potential to alter how we work. A big fear out there involves the possibility of AI replacing our jobs. And while this will be true to some extent, the bigger theme will be how AI augments the capabilities of workers by automating much of their workload, freeing up their time for other types of activities. Most jobs and industries are only partially exposed to automation, and thus are more likely to be complemented rather than completely replaced by AI. When we've seen revolutionary technological advancements in the past, those jobs that are displaced by automation have historically been offset by the creation of new jobs. The development of new occupations following these innovations has accounted for the vast majority of long-run employment growth. The real value lies in the idea that machines will enable humans to focus on the parts of their jobs that add the most value. Early Projections Point to Broad Growth Financial markets are just beginning to grasp how large of an impact AI will have on business and society at large. All of us are now together in this journey to understand the true capability and reach that AI will have, as the movement is set to potentially unlock trillions of dollars in economic value. From financial services to life sciences, AI will boost performance across sectors. Global consulting firm McKinsey conducted a study that suggests generative AI could add the equivalent of $2.6-$4.4 trillion annually, with the majority of value being delivered across customer operations, marketing and sales, software engineering, and research and development. Another recent study conducted by Accenture suggested that AI will nearly double global GDP in the next 20 years. Those are numbers we haven't seen since the 1980s. Similarly, a research report from Goldman Sachs indicates that generative AI could boost global GDP by 7% (or almost $7 trillion). The market's risk-reward profile has improved significantly relative to last year. If the market's long-term upward trend has indeed resumed, it needs to be supported by an increasing appetite for risk. This has certainly been the case this year, with a host of AI-related stocks and ETFs surging higher. The recent strength has improved probabilities that this bullish AI theme will revolutionize the investment landscape, similar to the way things shifted with the explosion of the internet back in the ‘90s. Continued . . . [Rare Opportunity for Zacks Members]( Today, we're temporarily reopening our Headline Trader portfolio to a limited number of investors. It catches stocks with strong fundamentals and earnings estimate revisions just as they're ignited by developments in the news. With AI dominating the headlines, the portfolio recently added 2 stocks fueled by powerful AI technology. Both have global reach and significant upside potential. Headline Trader is generally closed to new members. The doors are only open until midnight Sunday, September 3. Don't miss out. [See Stocks Now »]( 1995 – A Blast from the Past? Fortunately, we have evidence from the 1990s to help support our case. For a period of about 10 years, there was a surge in productivity growth during that time, driven mainly by large investments in computers and communications. This new internet wave transformed the business environment. I'm not big on analog years, but the current year is displaying some striking similarities to that of 1995. With a relatively high correlation coefficient between the two years, it's easy to understand why they have a lot in common. The S&P 500 returned 18.6% through the first half of that year, roughly in line with 2023. The Fed Funds Rate was also headed higher through the first half of '95, just as it has been this year. The second half of that year returned 13.1%, ending in a total annual return of 34.1%. We also did not have a recession in 1995, and it appears very unlikely we will experience one this year. Perhaps the less visible similarity that this year shares with 1995 is the fact that a bullish technological theme was developing. While the invention of the internet was made in the prior decades, the phenomenon really caught on in the mid ‘90s. The number of websites grew from 130 in 1993 to over 100,000 at the start of 1996. This year, the onset of artificial intelligence has been all the hype, bolstering the stock prices of technology stocks. Advancements in digital technology can drive broad economic growth. It happened less than thirty years ago, and the AI revolution is set to spark another round. What About Earnings Estimates? The rally this year has been based on strong fundamentals including positive earnings estimate revisions in several sectors, which our research has shown to be the most powerful force impacting stock prices. Over the long run, stock performance tends to follow the path of corporate earnings. While earnings have shown a clear decline year-over-year in the second quarter, the percentage of companies beating earnings estimates is above the 5-year average. This has helped to paint an earnings picture that reflects a stable and resilient backdrop. We knew coming into the year that continued earnings declines were likely, but the better-than-expected results are what have helped stocks rally this year. Remember, markets are forward-looking, and the anticipated results were already priced in. So, if companies surprise even just a bit, it can trigger powerful upside momentum as we've seen. Future earnings estimates have also begun to stabilize, and are even seeing modestly positive revisions in sectors such as technology. Part of this is due to the AI impact, and it's my sense that estimates will be revised even higher in the near future. Final Thoughts While the artificial intelligence movement has been in the making for several decades, 2023 will likely go down in the history books as the start of the AI revolution due to its widespread adoption via generative AI applications such as ChatGPT. Former technological revolutions have helped to automate tasks, drive down inflation, and increase corporate earnings. We expect that generative AI will have enormous effects on the broader economy as well as labor productivity. Faster productivity growth has raised living standards in the past. As more AI tools are developed, businesses across the economy stand to benefit. From enhancing office productivity and the layout of buildings, to improving patient-doctor communication in medical settings, the applications for AI are boundless. Generative AI is just the beginning; a full realization of the benefits of AI will evolve over time. It's Your Time to Profit from the AI Boom At Zacks we launched a portfolio service specifically designed to take advantage of this historic time for the stock market. Until midnight Sunday, you are invited to gain access to our Headline Trader. As director of the portfolio, I constantly monitor stocks with strong fundamentals and rising earnings estimates, watching for the first stirring of movement, checking for headlines and upcoming events. AI is dominating the news today. The technology is expanding at blinding speed, making this an exceptional time to profit. In recent weeks, I've added 2 AI-driven stocks with significant upside potential to Headline Trader portfolio: • A manufacturer that launched an AI robotics division that's now operating in more than 15 countries. • An internet tech company with a highly sought-after service that now gives users the ability to leverage AI for content creation on the platform. Some investors have already banked triple-digit gains on AI-driven stocks, but I believe even bigger profits are on the horizon. Bonus Report: Just for exploring our Headline Trader picks, you can download Zacks just-released Special Report, 7 Best Stocks for the Next 30 Days. Our experts comb through 220 Zacks Rank #1 Strong Buys and hand-pick 7 compelling companies likely to jump sooner and climb higher than any other stock you could buy in September. This opportunity ends at midnight Sunday, September 3. Sorry, there will be no extensions. [See Headline Trader and download 7 Best Stocks now »]( All the Best, [Bryan Hayes - signature] Bryan Hayes Zacks Strategist Bryan Hayes, CFA manages our Zacks Income Investor and [Headline Trader]( portfolios. He employs a combination of fundamental and technical analysis and has developed a unique approach to selecting stocks with the best profit potential. You can also find him covering a host of investment topics for Zacks.com. This free resource is being sent by [Zacks.com](). We look for investment resources and inform you of these resources, which you may choose to use in making your own investment decisions. Zacks is providing information on this resource to you subject to the Zacks "Terms of Service". Past performance is no guarantee of future results. Inherent in any investment is the potential for loss. 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