Is it time to rip up our favoured playbooks? No, I’m not trying to steer Andy Farrell after that first half ‘traffic cone’ tackling effort in Paris. Nor will I hold out any hope of Britain’s Labour Party saving its government from the existential fallout of ignoring its own “Prince of Darkness” links to Epstein. Sir Keir Starmer’s premiership is already “dead in the water” but I will stick with the trading theme. Long-time political commentators are rightly appalled that Peter Mandelson tipped off Jeffrey Epstein and his elite rolodex/assets about a €500 billion bailout of the euro currency during the Greek debt crisis. The €500 billion number is huge in its own right but the derivative opportunities in banking debt, currencies, bond markets etc at the time were in the trillions and available for exploitation by Epstein & Co without any obvious trace. So, following on from last week’s article, we promised to dig deeper into the huge AI numbers hitting our screens. Actually, we won’t. Instead, we will focus on a related huge number with potentially massive knock-on/derivative investment implications.
For me, the big number this week is the $1 trillion of value wiped from software stocks (and their SaaS subscription/business models) in just 6 days of trading. Of course, this is directly connected to the threat of AI and some developments, in particular, from the Anthropic/Claude suite of products which are making massive strides in assisting coders and companies to develop/manage their own work processes. Software, of course, is the incumbent go-to solution for companies seeking to optimise work processes and engagement with their customers. Indeed, the venture capital guru, Marc Andreessen, in 2011 was moved to say “software is eating the world”. From Netflix to Uber to Amazon, digital subscriptions gave companies and consumers access to technology-optimised services. As AI invades the digital opportunity, software is possibly no longer the ‘always’ solution on the Boardroom table. In fact, software could be on the displacement menu itself. The twin threats of AI are summarised well by Business Insider:
“First, if employees get more efficient using AI tools, companies may not need to buy as many business software subscriptions. That would dent the growth of “seats” or how many subscriptions software companies sell. Each employee has a seat, so if there’s no new hiring, growth stalls.
The second threat is more existential. If AI tools and AI agents get good enough, companies could replace the software they use entirely and instead rely on new AI-powered workflows. And with AI coding tools showing big improvements lately, companies could even develop their own software, without needing to buy it from established vendors.”
There are plenty of analysts and observers who disagree with the gloomy interpretation of AI’s eventual impact on software companies like SAP, Salesforce, Adobe, Figma and HubSpot. However, these company share prices falling by 30-40% in just one month, is telling us the ‘fear’ is real. The $1 trillion of value evaporation in less than a week is not an earth-shattering number given some individual companies are valued in the trillions alone. But… perhaps looking at the software value obliteration in isolation is misguided. The commentariat might think software fears are ‘overdone’ but, if you have a pension, this might be the less scary of TWO outcomes. The first is that software stocks growth and valuations are hit severely by AI replacement. However, there’s a second set of updated numbers/data to take a look at. While the software sector was being hammered, the AI/Cloud giants were announcing quarterly results. Interestingly, their earnings and sales growth numbers were pretty much ignored as the market focused on just one number; capital expenditure spend on AI infrastructure and development. Last week Facebook promised $135 billion of INVESTMENT in 2026 which equates to their total sales in 2023. Microsoft told us their number was circa $105 billion. This week it was Google and Amazon’s respective turns to talk the AI ‘space race’…
Google, perceived as the AI leader these days, told the market it would spend a cool $185 billion. That equates to its total revenues in 2020(!). Meanwhile, Jeff Bezos seems happy to test out the theory that “Democracy Dies in Darkness” at the investment-starved Washington Post, as his primary wealth creation vehicle, Amazon, announces a planned $200 billion capex spend for 2026. So, the Big 4 are up for a $625 billion investment splurge this year and probably every year for the foreseeable future. That looks like a bet of $3 trillion to $5 trillion on AI, and I’m just wondering what the ‘risk’ calculations could be? I chose the ‘space race’ phrasing earlier deliberately. It feels like the prospect of AI failure for these companies is existential in terms of economic power and analogous to the geopolitical calculations at the height of the Cold War in the 1960s. Well, the historians would probably agree that Reagan’s “Star Wars” broke the Soviet empire. It’s too early to tell who will ‘break’ in the AI race but software is in the crosshairs right now. However, the sense that big tech including software is ‘going for broke’ introduces a very new risk for financial markets.
The beauty of software and SaaS business models is recurring revenues, huge scalability at minimal incremental cost, 80-90% margins and enormous cash flow generation. The end result can be seen in the massive spending plans of Big Tech; these companies’ balance sheets were sitting on enormous cash piles (or equivalent liquidity). Simply put, these were the most robust (credit risk) companies on the planet. Pension funds, family offices, sovereign wealth funds and Swiss bank accounts loved the security/risk safety attached to loans and bonds issued by tech/software companies. These instruments were considered “defensive”. Now, not so much.
Stock/equities markets (as my former boss Terry Smith used to point out to me) occupy 28 of the 30 pages of the Financial Times. But, the last two pages covering debt, currencies, commodities etc are much more significant for financial markets. Now the bonds and loans associated with big technology companies are receiving intense scrutiny (and investor selling) as they each seek to out-spend their cash and balance sheet credibility. This has incredibly important implications for your pension. The credibility of the United States and global technology stocks are being reviewed for their ‘risk safety’. Some serious investment institutions are already acting and re-positioning. This doesn’t mean just selling. What investors are buying at the moment is telling too. Here’s a few data snippets to alert you to what is happening right now….
*Software sector selling activity is the worst since 2008
*Software valuations – forward price/earnings multiples of 20x – are now at levels (low) not seen since 2014.
*Now the buying: defensive consumer staples companies (Nestle, Mondelez, Heinz etc) have been up 1% on consecutive days while technology sector companies fell 1% on the same days. That divergence of performance has not happened since ….2000.
*The same consumer staples stocks are experiencing buying intensity (“RSI” for the technicians) not seen since 1995. Other indicators (DMA 200 day) are 4.2 standard deviations above average.
It looks like people are buying ordinary stuff; petfood, protein, household goods, chocolate….. really boring but real. We have written before that investors are flocking to atoms (real) and hedging/selling their risk with bits(digital code). One suspects the meltdown in crypto land (Bitcoin at $65,000, down over 50% from its highs) is also partly driven by digital ‘fear’. So, for those keeping an eye on the headlines and their pensions, you might want to check with your advisors on three areas:
- Pension exposure to technology (software or AI spend). It could be as high as 30% of your portfolio.
- Pension exposure to defensive real stuff. It could be as low as 5% of your portfolio.
- Pension exposure to the USA. It could be as high as 70% but there is currently a lawless armed militia running around the country, a Supreme Court in dereliction of its duty, international grift on an epic scale and the real threat of mid-term election suspension.
The advisors won’t have all the answers but it should be on ALL pension radars. This period of history offers mind-boggling opportunity but we must be also aware that there is an unusual confluence of technology ambition/confidence and global political leadership operating in an environment where traditional values and rules are being disregarded. Hopefully, rules-based leadership will return soon but here’s a warning from Andrew Ross Sorkin’s book, 1929:
“It’s a haunting elegy for a fractured era, a timeless reminder that progress is fragile, choices have repercussions, and the flaws embedded in the human condition are ours to confront”
Might be time to make better choices and confront those flaws (including White House ape videos)….
