Microsoft’s results have highlighted the costs of AI and put pressure on Big Tech.

Microsoft's results have highlighted the costs of AI and put pressure on Big Tech.

The Battle for AI Supremacy Takes a Toll on Tech Giants

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The high-stakes battle for artificial intelligence (AI) supremacy is beginning to take its toll on some of the leading tech giants in the US. Microsoft’s recent financial results have revealed the cost of investing in AI, causing a dip in the company’s stock price. This setback may have repercussions for other technology companies that have enjoyed significant gains in recent months, fueled by the hype surrounding AI.

Microsoft’s shares fell by 3.6% in early trading as the company disclosed its aggressive plans for AI-related spending. According to Microsoft, deeper investments in AI are necessary before the potential gains make their way to the bottom line. This announcement caused concerns among investors, leading to a potential $100 billion market capitalization loss for Microsoft if the losses hold until the close of trading. Prior to this setback, Microsoft’s shares had surged by an impressive 46.4%.

While AI is expected to generate substantial revenue and profitability for tech companies, the sudden drop in their stock prices suggests that many investors had bought into the hype without fully understanding the implications for company performance. Paul Nolte, senior wealth advisor and market strategist for Murphy & Sylvest, highlighted the current market sentiment, stating, “There’s still a lot of excitement around AI, but nobody quite understands what that means for the bottom line of many of these companies.”

The wider market was also affected by Microsoft’s announcement, with the NYSE FANG+ index, which houses many megacap growth names, slipping by 0.2%. However, Google-parent Alphabet was an exception to the trend, with its shares rising by 5.6% after beating second-quarter expectations. Alphabet is set to add about $100 billion to its market capitalization.

Microsoft’s recent rally has significantly increased its valuation, with the stock now trading at a price-to-earnings (PE) multiple of 31 times 12-month forward earnings, compared to Alphabet’s PE multiple of 20. This disparity reflects the market’s optimism combined with the uncertainties surrounding the true financial impact of AI on these companies.

The tech earnings season has opened on a mixed note, according to Mark Haefele, global wealth management chief investment officer at UBS. The upcoming quarterly results will play a crucial role in determining the performance of tech stocks throughout the rest of the third quarter. The highly anticipated reports from Apple Inc, the world’s most valuable publicly listed company, and Amazon.com Inc are expected to provide further insights into the industry’s outlook.

In addition to the challenges posed by AI, investors are also cautious due to a likely Federal Reserve interest rate hike that could push borrowing costs to their highest level since the global financial crisis. Large tech companies heavily rely on borrowed money, making them vulnerable to the consequences of higher interest rates. However, the positive sentiment surrounding AI and hopes that the Fed is nearing the end of its rate hiking cycle have supported tech stocks in recent months.

Stuart Cole, chief macro economist at Equiti Capital, highlighted the sensitivity of tech stocks to central bank policy sentiment. Robust economic growth is essential for these companies to deliver the promised returns. While concerns about a weakening US economy exist, the hawkish stance of the Federal Reserve will likely persist until sustained evidence of softening inflationary pressures emerges. This approach carries the risk of tipping the economy into negative growth.

Meta Platforms Inc experienced a 1.0% surge in its shares after Alibaba’s cloud computing division became the first Chinese enterprise to support Meta’s open-source AI model, Llama. On the other hand, Amazon’s shares took a hit, dropping by 1.3% following reports that the Federal Trade Commission is finalizing an antitrust lawsuit against the company.

Snap Inc faced a significant setback with a tumbling 18.3% decline in its shares after reporting a weaker third-quarter forecast than analysts had expected. Bernstein stock analyst Mark Shmulik wrote, “Band-Aids not fixing bullet holes yet,” referring to the struggles of Snapchat, owned by Snap Inc, to consistently grow revenue and close the gap with competitors like Facebook-owner Meta. Despite efforts to attract more users through AI-powered chatbots, Snapchat continues to lag behind its rivals.

The battle for AI supremacy continues to shape the fortunes of tech giants. While the potential rewards of investing in AI are promising, the true financial impact on company performance remains uncertain. As the tech earnings season unfolds, the market anxiously awaits reports from industry leaders, hoping for further insights and clarity regarding the future trajectory of the sector.

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