For those of you who pay attention to more than just insurance, you are likely aware it was a bad week for tech stocks. Software stocks have been crushed due to fears that AI will make them irrelevant while large tech also sold off over fears they are investing too much in AI and they won’t earn an adequate return.
The Conundrum?
Many market observers have observed this is counterintuitive. Either AI CAPX will be bad and software companies will thrive or CAPX will be good and you should buy Amazon, Google, etc. because they will dominate the AI future.
Fun fact: they’re both wrong!
The Missing Link
The above perspective is level one analysis and ignores what’s really going on. In my view, the market is clearly stating that AI will be successful. This is why software stocks have been decimated.
So why are the big AI spenders also selling off? Because the wisdom of crowds has correctly deduced that just because there will be a lot of AI revenue doesn’t mean there will be a lot of AI profit.
This is what the so-called “experts” are missing.
If AI does generate a lot of revenue, then software companies will likely lose market share to AI. This is bad for markets in total because software requires very little investment to generate revenue. This is what makes it such a wonderful business. It’s the equivalent of an insurance broker without the people costs.
On the other hand, AI revenue requires massive investment. Even if it isn’t being wasteful (which is a low probability – the debate is more over how much is wasteful), it requires trillions of dollars of upfront capital.
Worse, it is not a one time buildout like say the highway system or Hoover Dam. Every few years, there will be technological improvements which make the current infrastructure outdated and trillions more will have to be invested to keep up with the new state of the art.
This is a worse model than being a reinsurer! Sure, there’s a ton of revenue but it’s like if every time there was a large cat, your cat models and claims organization became obsolete and you had to build completely new ones *and* you also had to raise new capital because S&P decided cats require twice as much capital to write as the day before.
Listen To The Market
So what the market has been trying to tell us over the last week or so is that it hates that tech is transitioning from a low capital intensive, high margin model to a highly capital intensive and more volatile model.
One of the lessons you learn as an investor (at least if you want to be a successful one) is that, most of the time, when the market is trying to tell you something and you think you know better, the market is usually the one that’s right (at least in the short term).
Investors who aren’t listening and keep insisting that software and large tech being down at the same time is a paradox are not paying close enough attention.
Now, as noted, the market can change its mood quickly, especially as new data points arrive, so it’s very possible that AI will disappoint and software will recover.
But if AI meets its expectations, it’s still unlikely to be good for those spending trillions on its buildout. The real winner in that case is likely to be Corporate America (and World) who generate large productivity improvements without having incurred the CAPX burden.
New Format
That’s it. That’s the note for today. I’m trying something a little different. I have more to say on this topic and how it affects insurers in the future but rather than take longer to get out a longer piece and not be as timely, I wanted to experiment with getting out quick thoughts that are more immediately relevant.
Not sure if this will be an ongoing effort or not, but I suspect that I might try to do quick notes like this more often, especially when it is in response to something timely.
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