AI Isn’t a Catch-All Trade for Stocks in This Earnings Season

(Bloomberg) — Equity investors are learning a harsh lesson this corporate earnings season: Not all artificial intelligence trades are created equal.

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While profits at S&P 500 and Stoxx Europe 600 constituents as a whole are tracking one of the best quarterly increases in years, traders have been much more discerning about how much cash is being spent on developing generative AI.

Shares of tech heavy-hitters such as Meta Platforms Inc. and Alphabet Inc. have been penalized after the companies signaled even more capital expenditure, while the likes of Microsoft Corp. have been rewarded for preserving their cash reserves.

The semiconductor supply chain has also felt the ripple effects, with Lam Research Corp., Schneider Electric SE and Prysmian SpA among the outperformers on robust demand for their technology that enables AI.

“Earnings have remained resilient, but investors have become much more disciplined about paying ever higher valuations for large-cap technology,” said Violeta Todorova, senior research analyst at Leverage Shares. “On the other hand, Europe has quietly delivered improving profit expectations across a broader range of sectors.”

S&P 500 firms are on track to post a 29% surge in second-quarter earnings per share, among the highest on record outside of post-crises recovery years, according to data compiled by Bloomberg Intelligence. And yet, the S&P 500 has gone nowhere since the season began in mid-July, weighed down by the largely underwhelming response to big tech.

On the other hand, European stocks are seeing the boost from strong results as they have a lower concentration of tech heavyweights. The Stoxx 600 has advanced 1.3%, and briefly hit a record, as its members posted a 19% surge in profits, according to Barclays Plc data, after earnings barely rose in the past two years.

“We had reduced our exposure to the US and rotated partially to Europe prior to the earnings season,” said Amelie Derambure, a senior multi-asset portfolio manager at Amundi SA. “We weren’t comfortable with the weight and concentration on the broad AI theme, but we were expecting Europe to deliver on demanding expectations in terms of earnings — and it did.”

Tech Divergence

That skepticism about AI has shown up in the reaction to Big Tech results this season.

Shares of Facebook owner Meta sank 8% after it gave a disappointing quarterly revenue forecast and reported the lowest free cash flow in years, a sign of ballooning expenses for AI bets.

On the other hand, Microsoft soared 16% to add nearly half a trillion dollars in market value, the most by any stock in a single day. The catalyst: The fastest cloud growth in four years and indications that the company would hold the line on new capital spending this year.

Amazon.com Inc. shares jumped 15% after the company reported upbeat cloud-computing revenue, easing concerns about the payoff from huge expenditure on AI.

“At some point, investors are going to get weary of all the spending by the hyperscalers,” said Bob Lang, founder and chief options analyst at Explosive Options. “It should come as no surprise to see a firm rewarded for backing away.”

Global stocks in the AI supply chain as well as those that enable and adopt the tech also appear to be back in favor.

A UBS Group AG basket of so called AI winners rallied 11% in the past two sessions after a slate of reassuring earnings reports. The gauge, which includes the likes of Sandisk Corp., ASML Holding NV and Taiwan Semiconductor Manufacturing Co., had sold off in July on worries about ballooning valuations.

Earnings Optimism

One bright spot is a strong showing from sectors beyond technology. Financial, energy and healthcare are among the standouts in both the US and Europe in terms of the number of companies beating analyst estimates for the second quarter, data compiled by BI show.

Profit expectations are still rising, both in the US and Europe, underscoring optimism around economic growth and easing inflation despite lingering concerns around geopolitics.

Companies on both sides of the Atlantic have boosted guidance at one of the strongest rates in recent years, Barclays strategists said.

US earnings revisions — the number of analysts raising their estimates minus those cutting them — have also seen net upgrades for 15 weeks in a row, the longest streak since 2022, according to a Citigroup Inc. index. In Europe too, the highest number of analysts have boosted expectations since 2021.

For some investors, that resilience is providing hope that the worst reaction to earnings may be over.

“Good earnings were not good enough initially for many,” said Ken Mahoney, chief executive officer of Mahoney Asset Management. “Now that we have gotten past a lot of these earnings and seen some pretty significant corrections in individual names, we are watching to see if they can stabilize and find some higher lows.”

–With assistance from Julien Ponthus, Matt Clinch and Subrat Patnaik.