The next phase of the AI boom is likely to be about real-world applications rather than simply bigger models and data centres, offering opportunity for UK players. Investors should focus on diversification, quality companies and defensive sectors which remain important anchors amid the volatility.
Susannah Streeter, Chief Investment Strategist, Wealth Club: ‘’The tech sell-off has intensified, with the pain of the brutal sell-off on Wall Street carried straight through to Asia and knocking sentiment in Europe. Big worries are colliding – the build-out of data centres looks set to slow, which risks shredding the spending spree underpinning the boom, right at the time that investors have become super nervous about returns on this massive investment.
While the Footsie is set to be more insulated, given its tech-lite nature, it’s not immune, given the fortunes of listed multinationals depend on the health of the global economy. Sentiment is souring and the blue-chip index is expected to turn sharply downbeat at the end of a turbulent week. Any slowdown in AI generated growth, particularly in the US, will have repercussions for the wider market, and it comes as inflationary pressures are still playing on minds. Oil prices have crept higher yet again, as uncertainty swirls about the outcome of the middle East crisis, with fresh military action still potentially on the table.
However, further ahead the FTSE 100 could also benefit from a sharp rotation away from tech into more defensive sectors like consumer staples, pharma and utilities, but for now the broad deterioration in sentiment is set to weigh on the index.
Nerves frayed in Asia with margin calls threatening to compound losses
Nerves have been severely frayed in Asia. South Korea's Kospi plunged more than 8% in early trading, crashing below the psychologically important 5,000 level and triggering a 20-minute circuit breaker. It subsequently recovered some ground, with losses narrowing, but severe jitters remain.
Chipmakers which power the explosive growth of artificial intelligence have been particularly exposed to fears that the AI juggernaut will hit multiple roadblocks.
Samsung Electronics and SK Hynix, two of the biggest beneficiaries of the AI investment craze, have been among the hardest hit during trading in Asia. Another factor that appears to have exacerbated the sell-off is the threat of a wave of margin calls. Huge numbers of retail investors in South Korea have been borrowing money to pile into shares, caught up in the FOMO – the fear of missing out – as the market surged. But with those shares now plunging in value, investors who borrowed to buy them are coming under pressure to put up more cash or collateral to cover their loans. Those who can't stump up the extra money risk having their shares forcibly sold by their brokers. And that can create a vicious cycle – falling prices trigger forced selling, which pushes prices down further, potentially triggering yet more margin calls.
It's become such a concern that South Korean authorities are stepping in to give brokers more flexibility to avoid forced liquidations. They are temporarily suspending the requirement for investors to maintain collateral worth 140% of their credit-financed stock purchases, for three months from Monday. It will give brokers greater discretion to defer forced selling, although it is not a blanket ban on margin calls or liquidations. There are concerns that other risks linked to debt-fuelled bets on the AI boom will emerge, particularly if prices continue to fall. So, investors are bracing for another lurch of volatility.
What should investors do amid the volatility?
For investors, the temptation may be to rush for the exits, but knee-jerk reactions to sharp market swings can crystallise losses and mean missing out on any recovery.
It's important to distinguish between a genuine deterioration in the long-term outlook for a company and a sudden change in market sentiment. Investors should be revisiting the fundamentals - whether businesses can turn their huge AI investments into sustainable profits, whether their valuations still stack up and whether their balance sheets are strong enough to weather a more difficult environment.
The AI trade is evolving, presenting future opportunities.
This shock is by no means the end of the AI trade. The next chapter of the AI story won’t be simply about who can build the biggest models or spend the most on data centres and computing power. It's going to be about who can make AI work in the real world.
We're likely to see much greater scrutiny of capital expenditure and, crucially, the returns companies are getting from that investment. That creates opportunities for smaller, more nimble businesses building applications on top of the technology that's already been developed, without having to shoulder the enormous costs of creating the underlying models themselves.
And the UK has a huge breadth of talent to draw on especially given the partnerships between AI businesses and British universities which are particularly encouraging. The UK has world-class research expertise and entrepreneurial talent, with applications being developed that can make a tangible difference across industries, from healthcare to financial services and manufacturing.
Some UK technology businesses are operating at considerably lower valuations than their US counterparts. That could make them attractive to investors looking for the next wave of AI growth, rather than simply chasing the mega-cap technology companies.
During periods of volatility, time in the market and diversification have consistently been the foundations of successful investing. For investors owning quality companies over the long term, big bumps in the road are part of the journey. Utilities, healthcare firms, companies selling consumer staples, and those with reliable, high-yielding dividends tend to be more resilient in eras of unpredictability.’’
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