Tapping the Brakes on Futurism

There’s really no way to sugarcoat this: it’s an ugly day for equity investors.  As I type this, the S&P 500 (SPX) is down -1.75% and the Nasdaq 100 (NDX) is down -2.9%.  The megacap tech stocks are once again the culprit, thanks to poor reactions to earnings reports from Alphabet (GOOG, GOOGL; -4.9%) and Tesla (TSLA, -10.3%).  The root cause is less about the actual numbers than the dampening of enthusiasm about artificial intelligence and other futuristic developments.  And both moves are roughly in line with the options market expectations that we wrote about yesterday.

Even though TSLA is bearing the brunt of the declines, comments from GOOGL strike me as the bigger concern.  Its CEO, Sundar Pichai, threw some cold water on investors’ overheated expectations for AI during the earnings call:

But I think we are in this phase where we have to deeply work and make sure on these use cases [for their AI products], on these workflows, we are driving deeper progress on unlocking value, which I’m very bullish will happen. But these things take time. [emphasis mine] So — but if I were to take a longer-term outlook, I definitely see a big opportunity here.

Hmmm, where have we heard something like this before?  Oh yeah, we wrote about Mark Zuckerberg’s similar comments after Meta Platforms’ (META) April earnings call:

And I also expect to see a multi‐year investment cycle before we’ve fully scaled Meta AI, business AIs, and more into the profitable services I expect as well.

Comments like these hardly negate the expectation that AI can indeed offer meaningful improvements to the profitability of its key providers.  But investors seem to need reminders – painful reminders, sometimes – that AI’s contributions to their bottom lines might be years away and more expensive to achieve.  And this says little about AI’s contributions to ordinary users.  It offers the potential for efficiency, where technology replaces labor.  But in practice, at least in the short term, it requires very expensive investments in computing power and well-paid technologists to hopefully replace low-level workers.  That can be a difficult thing for investors to swallow, whether from technology providers or users.

I don’t enjoy making comparisons to the current AI enthusiasm with the 2000-era internet bubble because they’re imperfect at best.  But there is one that bears repeating.  The internet proved to be everything its most wide-eyed advocates hoped for, and more.  Yet it took longer for those achievements to reap the returns on investment that investors originally expected.  It is also useful to bear in mind that the two internet leaders we’ve discussed thus far – GOOGL and META – didn’t even exist during the internet bubble.  Could it be that the company that best figures out how to utilize the promise of generative AI exists either in a garage somewhere or even only in a teenager’s imagination?

That said, GOOGL’s business in the here and now is doing just fine.  Revenues and earnings both beat expectations and grew rapidly, up +13.6% and +32% respectively over the past year.  And even after spending a staggering $13.2 billion on capital expenditure, its free cash flow was still $13.4 billion.   Despite the disappointment over the pace of AI profitability, this is a huge growth stock that is growing rapidly.

Unfortunately, the same can’t be said for TSLA.  Revenues beat expectations thanks mainly to a surprise bump in regulatory credits, but they are still up only +2.3% from a year ago.  Meanwhile, its adjusted EPS of $0.52, which is -28% below the year ago number, missed expectations for the fourth consecutive quarter.  TSLA is no longer a growth stock in the classic sense.  It’s always been about the future, even when its bottom line was growing exponentially.  Unfortunately, that company’s future is also further away than hoped.

We received official confirmation of the reports that the promised robotaxi unveiling would be postponed from August to October, but also learned that any cars unveiled would only be prototypes.  More affordable models won’t be ready until the first half of 2025 at the earliest.  A hoped-for humanoid robot won’t be available until at least late 2025.  And in a blow to the AI poster child, Nvidia (NVDA), the company reiterated its commitment to its Dojo computer project.  If the present is rocky and the future is murky and further away, it’s not a surprise to see the stock selling off sharply.

Is there any good news today?  Perhaps.  For starters, we have the Russell 2000 (RTY) and Russell 1000 Value ETF (VONV) only down slightly, so we still see signs of “routation” rather than “get me out”.  That is echoed by the fact that declining stocks on both the NYSE and Nasdaq are only outpacing advancers by about 1.5:1.  Also, at least so far, we are still avoiding the ever-rare -2% decline in SPX.

And if we want to look at a half-full glass, perhaps today’s reaction to GOOGL’s earnings means that expectations for the upcoming earnings in other key AI-related stocks, like META and Microsoft (MSFT), may have come down to earth somewhat.  Investors set very high bars for many of their favorites.  Perhaps they have been lowered just a bit.