The Swanger Series: 2024 Outlook – Part 5

What 2024 has in store for investors: Part 5

Last edition I elaborated on Risk #4 – Sustainability. You can read about it here.

Risk #5: Artificial Intelligence and the Digital Economic Revolution

Much like sustainable investing, the Digital Economic Revolution is and will continue to change the global economy. But also like sustainable investing, there is no history that can be relied upon to get a reliable picture of what is a reasonable premium to pay for assets that will benefit from this change.

That change, again like sustainable investing, has moved from niche to mainstream in terms of its impact on investment markets. That means that it cannot be ignored. It doesn’t mean however that one has to believe artificial intelligence will fundamentally change investment markets or be positive for certain assets. But it does mean that the time has come to understand how this technology will change markets’ pricing, particularly given the attention that both of these themes are receiving from investment media and researchers.

The Digital Economic Revolution can transform the global economy in a material way, but only if it brings changes that have economy-wide impacts, not the relatively niche changes to date. The digital economy has mostly changed consumer logistics, with capital markets’ impacts largely focussed on economy-wide providers such as Apple, Nvidia and Facebook.

But this is the not the fundamental change that the steam engine or electricity had in the Industrial Revolution. Artificial Intelligence (“AI”) is the first of these more fundamental changes of this economic revolution. The trick, as always, is to pick such fundamental changes before the herd, but not too much before. Economies, companies, and families that supported these changes in the Industrial Revolution are still benefiting from the wealth gained more than 100 years later.

Believe or don’t believe: Just understand the trend and its impact

AI is being included as one of the major changes to the global economy because we believe that it will be such a fundamental force. However, the power of IAM’s direct model, of course, is that you can read the argument for AI, but conclude that we’ve got it wrong and take the other side of that trade (ie buy those assets underpriced by everyone else believing in AI).

That said, the position here is that AI will impact global markets, particularly their volatility as markets try to predict the impact of AI on the real economy. Regardless of the magnitude of its impact, AI will cause three fundamental changes to capital markets:

1. A direct impact on capital markets as the demand for capital shifts from operating capital (for labour) to investment capital (for technology investments);
2. Productivity improvements, depending upon the economy’s encouragement of innovation; and
3. Finally, AI will shift capital to those parts of the economy most likely to profit from the changes that AI brings eg infrastructure providers such as data centres, software providers and other technology infrastructure providers; and those sectors much disrupted.

The scale of this impact is huge, hence the opportunities and risks for investors. Some researchers have been specific about forecasting this impact, while others (like JPMorgan and the IMF below) have been less specific but no less dramatic in their predictions.

• Goldman Sachs have estimated an average impact of 1.5% per annum productivity growth over the next 10 years.
• Capital Economics , a more independent researcher, concludes a similar global uplift, but also concludes that that positive impact is most acutely felt in countries that encourage innovation.
• Capital Economics have predicted the US, Canada and the UK will see productivity gains leading the world in the 2030s, with the US seeing even higher productivity gains than the 1990s, during the second phase of the internet’s economic impact. They have gone as far as to state that the US is now likely to remain as the world’s largest economy by 2040, keeping ahead of China due to the US’s stronger encouragement of innovation.
• JPMorgan has sensationally opined that AI will have a larger impact on the global economy than electricity and that it “has the potential to augment virtually every job”.
• On a similar line, the IMF has predicted AI disrupting around 40% of global employment.

AI also creates investment risks

But AI also creates investment risks that will create valuation bubbles and disrupt monetary policy over the next decade. Like any major disruptive force, AI will disrupt market valuations; it will displace some workers but create more opportunities for others; and it will force investment market forecasts to throw away old assumptions about earnings and economic growth.

What’s more, the impacts are not limited to the technology sector, or the old school sectors that are disrupted. Assets such as office property are impacted by any change to employment trends, as we saw with the global pandemic. The impact for property investments is particularly uncertain, hence particularly risky, given the impact on employment.

Robots won’t be taking over the world

Let’s be clear on this topic though: We are not talking about AI helping robots take over the world in 2024.

AI is like a really talented intern with a bad memory. Give them a repetitive task with clear rules, and AI-powered software can do that task in a fraction of the time that humans can. Ask AI or interns to use their experience and think laterally, and the results are terrible.

However, AI’s first and likely most significant impact will be to remove the administrative, repetitive tasks involved with almost all industries, and for many industries, it will dramatically reduce costs.

Conclusion

From an investments’ viewpoint, what revolutions tend to do is create permanent change (opportunities) and bubbles (risks). There is no great mystery as to why this happens: Rapid and significant change moves wealth, creating greed, and meaning that the next wave of change has more people backing it. So it would seem the question is now more about where this revolution will take us, and which empires and individuals will “win” from the revolution by the time it ends.

Craig Swanger,

Chief Investment Officer, IAM

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