Despite a bumpy ride, global equities have made a positive start to 2023. The MSCI ACWI entered May 9.0% higher, largely driven by solid returns across developed markets, with European stocks particularly strong. Globally all sectors have delivered positive returns year-to-date, although the gap between the best performers (information technology +20%, communications +19.3%) and the weakest (energy +1.1%) is stark over a relatively short period.
Also notable is that growth-orientated sectors have delivered such strong returns against a backdrop of ongoing monetary policy tightening – typically a headwind for longer duration stocks – with central banks in the US, Europe and elsewhere continuing to fight inflation by raising interest rates. Perhaps less surprising given the hype surrounding the launch of ChatGPT, is that stocks linked to artificial intelligence (AI) have powered much of the market's year-to-date gains.
In the US, six companies – Microsoft, Alphabet (Google), Amazon, Meta (Facebook), Nvidia and Salesforce – have generated half of the S&P 500's +9.0% return, helping to offset losses in the financial sector following high-profile bank failures. They have also more than compensated for deficits in the education sector where student interest in ChatGPT has inflicted big losses on study content providers like Pearson, Duolingo and Chegg.
The US technology sector's quick-fire gains have already recouped most of 2022's losses but also reignited fears of a stock market bubble. The sector's P/E of 25x is similar to pre-correction levels of a year ago and IT stocks now represent over a quarter of the overall S&P 500 index. This concentration risk could be especially dangerous for passive investors – suffice to say that stock selection right stocks has rarely looked more important for downside protection.
Growth exposure at value prices
Many of the 'AI winners' are owned by our equity funds, helping them to deliver positive absolute and relative returns for clients so far this year. As well as Microsoft and Alphabet, SKAGEN Global holds ASML, the Dutch semiconductor equipment manufacturer which is likely to benefit hugely from the rapid adoption of AI technologies. Combined, these three companies have contributed +9.4% to portfolio returns in 2023.
SKAGEN Kon-Tiki owns the world's two largest memory chip makers, TSMC and Samsung, which supply the hardware for AI devices, while long-standing exposure also comes via Foxconn, a key player in developing China's machine-leaning capabilities. These three holdings have added 8.4% to the fund's year-to-date returns.
The longer-term disruptive force of AI will be felt far beyond the companies helping to develop its technology and the businesses most threatened by their rapid progress. ChatGPT has grabbed recent headlines but AI has already changed how we live and work – think navigation apps and virtual assistants. Its longer-term impact could be as transformative as the internet, mobile phones and WiFi – think autonomous vehicles and new medical treatments.
Companies across all sectors will need to embrace the paradigm shift that machine-learning represents. An 85% increase in mentions of 'AI' on company earnings calls this year suggests that management teams are embracing the change. For investors, the possibilities are equally exciting and broad. One study of ChatGPT alone suggests that the share prices of companies with the highest employee exposure to the chatbot outperformed those with harder-to-replace workers by 0.4% daily.
A word of caution
Previous periods of technological transformation have coincided with some of the best stock market returns but before getting too carried away, history also shows the importance of valuation. The chart below plots the S&P 500 index (black line) against its cyclically adjusted P/E ratio (red line) with blue bars indicating periods with zero returns. It shows that phases of rapid digital change don't translate into stock market gains when valuations are high, as they are at present.
It also highlights why picking the right companies at the right prices is the most important driver of investment performance. Irrespective of where we currently are in the AI revolution, valuation remains the single most reliable predictor of future financial returns.
The art of common sense
Although machine learning is already disrupting many professions, picking stocks with consistent success is seemingly beyond its capabilities – at least for now. Several AI-powered funds have been launched with the aim of using machine learning, language and sentiment analysis to deliver market-beating returns. Their results so far are mixed, with most computer-generated portfolios underperforming over a meaningful three-year time period.
This isn't a surprise – markets move quickly, forecasting is tough and the best investors combine financial analysis, creative thinking and intuition.
In SKAGEN, as well as investing in the companies driving and prospering from AI, we see it as another tool that can benefit our own business and clients. It could help us to become more efficient in how we research companies and manage risk on the investment side, while enabling even more tailored customer service and advice would similarly aid the unitholders of our funds.
In the meantime, we will continue to think long-term – our portfolio managers identified Foxconn's AI potential back in 2020 – and separate hype from reality on behalf of our clients. In our 30-year history SKAGEN has embraced technological change more than most, but in managing your money we prefer to use natural common sense over artificial intelligence.
 Source: MSCI, all return figures in USD.
 Source: S&P 500 IT Sector factsheet, as of 28/04/2023.
 All attribution figures based on contribution to absolute portfolio returns in NOK.