By Lewis Krauskopf
NEW YORK (Reuters) -Optimism over the profit potential of artificial intelligence has helped drive the U.S. stock market to record highs, but investors are looking for weak spots that could emerge in the AI trade and have identified some risks to watch for.
AI has been the dominant theme on Wall Street since the launch of ChatGPT in November 2022, which fueled enthusiasm about the technology’s potential. Citigroup strategists estimate that nearly 50% of the S&P 500’s overall roughly $57 trillion in market capitalization has “high” or “medium” exposure to AI.
The benchmark index is up about 13% year-to-date, while the tech-heavy Nasdaq Composite has climbed 17%.
“So much of what is holding up the markets is either directly or indirectly related to that trade,” said Yung-Yu Ma, chief investment strategist at PNC Financial Services Group.
Technology and AI-linked stocks have stumbled several times this year. The emergence of a Chinese low-cost AI model called Deepseek at the start of the year sent shockwaves through tech stocks as it raised questions about massive capital spending. Similar questions also arose in August, briefly hitting tech stocks once again. The AI trade recovered from those setbacks and has thrived.
“There is a huge opportunity here, but it really just comes down to what’s priced in and what’s not,” said Steve Lowe, chief investment strategist at Thrivent Financial. “There is a lot of growth priced in, and that is one of the concerns, because there are still a number of risks that could trip up people’s expectations.”
While some of the market participants who point to risks remain bullish as the benchmark S&P 500 starts the fourth year of its bull run, investors have identified potential warning signs to watch for as tech and other major U.S. companies begin reporting quarterly results in the days ahead.
MASSIVE CAPEX SPENDING IN FOCUS
Given massive capital expenditures required to build out infrastructure tied to AI applications, investors said they will watch the rate of spending and return on investments, and the potential for outlays to erode profitability.
Capex from major cloud computing and AI platform companies known as “hyperscalers” including Microsoft, Amazon, Alphabet, Meta Platforms and Oracle, is expected to roughly double from 2024 to 2027 to $500 billion annually, according to Barclays strategists.
While these companies generate massive amounts of cash, it is important to watch whether they are “spending faster than their growth rates and eating into their free cash flow margins,” said Michael Arone, chief investment strategist for State Street Investment Management.
