UBS Signals Cautious Stance on U.S. Tech Amid AI Investment Surge
Swiss investment bank UBS has downgraded its outlook on the U.S. information technology sector, shifting its rating to neutral from attractive. This recalibration follows a recent sell-off in software stocks and reflects growing investor apprehension surrounding the impact of artificial intelligence (AI) and escalating capital expenditures within the tech landscape.
The core of UBS’s concern stems from what it terms “software uncertainty.” This ambiguity is fueled by several factors. Firstly, investors are becoming increasingly discerning about technology stocks, scrutinizing company fundamentals more closely. Secondly, there’s a noticeable rotation of capital away from the tech sector, as investors seek opportunities in more stable or less valuation-stretched areas. Most significantly, the rapid advancements in AI have raised questions about the longevity and market dominance of traditional software tools, particularly after AI firm Anthropic unveiled new tools capable of handling professional workflows, a segment traditionally dominated by established software providers.
This uncertainty has been amplified by recent market movements. While the S&P 500 Software & Services Index saw a rebound of around 3% on Monday, following the previous week’s downturn, UBS suggests that the underlying concerns may persist. The bank highlighted that increased competition within the software industry, coupled with the evolving landscape shaped by AI, is making it challenging for investors to confidently forecast the growth rates and profitability of software firms.
Mark Hawtin, global equities head at Liontrust Asset Management, echoed these sentiments, noting the current imbalance between AI-driven revenue generation and the substantial investment being poured into the technology. “The amount of revenue being generated by AI at the moment doesn’t stack up relative to the amount being spent,” Hawtin told CNBC. “So that’s just creating a picture out into the future, which is way more uncertain, way harder to predict, and investors don’t like unpredictability.”
Another significant factor contributing to UBS’s revised outlook is the unsustainable level of capital expenditure by cloud service providers. The bank cautioned that this spending spree could become an “overhang” for investors, especially as a substantial portion is being financed through external debt or equity. This is particularly relevant for the “Magnificent Seven” group of tech giants. For instance, Alphabet, Microsoft, Meta, and Amazon are projected to collectively invest nearly $700 billion in AI this year. Amazon alone anticipates spending $200 billion, which could lead to a negative free cash flow of approximately $17 billion by 2026.
“If I’m an investor, and I’m being offered $60 billion of cash flow today versus some cash flow in the future as a result of that spending, that creates uncertainty, and I should pay less for that,” Hawtin explained. “So the key for me with many of these Mag Seven names is that the risk has increased. They’re becoming very capital-intensive. We don’t know what the outcome of that capital expenditure is going to be, and therefore, we should pay less for them.”
Furthermore, UBS pointed to the fact that “tech hardware valuations look full,” suggesting that the valuations of many hardware stocks have reached a point where further upside potential may be limited, making them less attractive for investors seeking value.
Diversification Recommended
Despite the downgrade, UBS emphasized that this does not signify a negative long-term view on the technology sector as a whole. Instead, the bank advises investors to broaden their horizons beyond the traditional tech and IT sectors, as significant opportunities within AI exist across various industries.
UBS recommends that investors reassess their current allocations to U.S. technology stocks, particularly those exceeding benchmark levels. They also advise caution regarding concentrated holdings in individual software companies, especially “pure-play” firms lacking diversified business models. Instead, the bank suggests exploring opportunities in sectors such as banking, healthcare, utilities, communication services, and consumer discretionary. This strategic shift aims to mitigate risks associated with the current tech landscape and capitalize on broader market trends.
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