Introduction to AI and its Impact on the Economy
The advent of Artificial Intelligence (AI) is poised to significantly alter both the economic and investment landscapes. While the initial contribution of AI to economic activity has been largely due to capacity build-out rather than broad-based productivity improvements, it is essential to consider its potential long-term effects. The investment in AI has been dominated by the US, followed by China, indicating that the immediate economic boost is primarily investment-led and geographically uneven.
Early Adoption and Future Potential
Recent industry surveys have shown a significant pick-up in AI adoption in both the US and China, with some pockets of efficiency gains. However, companies are still in the early stages of AI adoption, and translating capital spending into sustained output-per-worker gains is a multi-year process. This process requires diffusion, reskilling, and complementary investment, suggesting that the full impact of AI on productivity is yet to be realized.
Cross-Country Differences and Investment Opportunities
The differences in AI capital expenditure (capex) across countries, both in scale and composition, imply that productivity paths may diverge over time. Economies with deeper innovation ecosystems, supportive regulation, and strong digital infrastructure are likely to capture efficiency gains more effectively. This divergence presents investment opportunities, particularly in the small cap space and emerging markets (EMs), as AI adoption broadens beyond the large US tech companies.
Investment Perspective and Risk Assets
From an investment perspective, the focus has primarily been on stocks exposed to the infrastructure build-out of AI. However, as AI adoption progresses, the market focus is expected to shift towards AI enablers and applications. Considering the acceleration and pace of the tech industry’s disruption, allocating to technology is crucial for potential wealth creation opportunities. We are constructive on risk assets, with a preference for equities, and see stronger returns in EM equities driven by superior earnings growth and more attractive valuations.
Potential Scenarios
Upside Scenario #1: Productivity Boom
If AI boosts productivity faster and further than expected, the global economy, led by the US, could experience rapid economic growth, potentially reaching levels not seen since the late 1990s. This would lead to a surge in global tech and EM equities, with inflation staying in check due to the disinflationary impact from enhanced productivity.
Upside Scenario #2: Russia/Ukraine Ceasefire
A ceasefire in the Russia/Ukraine conflict could lead to falling energy prices, recovery in Ukrainian production capacity, and potential removal of sanctions on Russia. This would accelerate European growth via higher real income and improved consumer and business confidence, benefiting European equities, credit, and financials.
Downside Scenario #1: AI Disappointment
If tech capex is significantly scaled down due to questions about the viability of current AI expectations, the US economy could slow, leading to a correction in global equities. Defensive sectors and high-dividend stocks would be more resilient, with European equities outperforming due to lower exposure to the AI theme.
Downside Scenario #2: Germany Letdown
Underdelivery by the German government on its infrastructure and defense budget could weigh on confidence, leading to below-expectation growth in Germany and the Euro area. This would pressure European domestically exposed stocks, but European core fixed income could provide a buffer as more cuts by the ECB are discounted.
Conclusion
In conclusion, the impact of AI on the economy and investments is multifaceted and significant. While there are potential upside scenarios, such as a productivity boom or a ceasefire in the Russia/Ukraine conflict, there are also downside risks, including AI disappointment or a letdown in Germany’s economic performance. Understanding these scenarios and diversifying investments accordingly can help navigate the complex landscape of AI-driven economic changes. As the world becomes increasingly dependent on technology, allocating to this sector and considering the potential implications of AI on various economies and markets will be crucial for investors seeking to capitalize on emerging opportunities.
