In last month’s Insights, we tackled the topic of cryptocurrency. In those comments I noted how polarizing the discussion around cryptocurrencies can be. Not to be outdone this month, we’ll tackle an even more hotly debated topic. Artificial intelligence (AI) is taking the world by storm and trillions of dollars are being spent and invested in this technology. Reactions to AI span everything from outrage when mentioned at college commencement speeches to claims that it has the potential to raise the IQ of every human on earth. In this month’s entry we’ll explore the current AI landscape, its potential for good and bad, and implications for us as investors.
What is Currently Happening
The concepts of AI and machine learning have moved from the theoretical to an increasing part of our daily lives. Several cases in point:
- The largest companies in the world (Nvidia, Microsoft, Google, Amazon, etc) are investing billions of dollars in both developing AI and building out AI infrastructure
- Data centers are the heartbeat of AI and are springing up throughout the country, often driving significant local debate and controversy in the areas where they are being built
- AI is disrupting entire industries (like coding for example) and is making certain jobs increasingly obsolete. This trend will likely only continue and intensify
- AI models are ever improving and outputs are getting more and more accurate
- AI is now embedded throughout our personal technology stacks and is increasingly part of our day to day lives. Even benign activities like Google searches now lead with AI summaries
- Education is facing huge challenges as AI threatens to circumvent historical learning processes at every level
- Companies are working through AI use cases for their businesses and this trend is expanding rapidly
As AI continues to expand, society as a whole will increasingly be impacted in both good and bad ways. AI presents an interesting dichotomy as each potential AI virtue seems to be mirrored by a potential AI vice. We’ll cover some of these in detail.
The Good
There are more potential positive use cases than we have space to mention here, but we’ll note some key ones. A primary potential economic benefit of a new technology like AI is productivity gains. As we look throughout history, novel technologies have always led to significant increases in productivity. For example, railroads made it possible to move goods and people at scale and far more cheaply than horses and wagons. Railroads made people more productive (able to produce more per unit of input) and improved the overall quality of people’s lives. New technologies that lead to productivity gains are also deflationary, meaning that they tend to push prices down. Why is this particularly important today? Because we have both inflationary trends and demographic headwinds. Take the United States for example. We currently have nearly $40 trillion in debt and have fewer people entering the workforce than leaving the workforce:
If debt continues to expand and there are fewer workers to foot the bill, something has to give. When countries face this dilemma, they have three primary paths: Austerity (slow spending and raise taxes; not popular or likely), Monetizing the debt (“printing money” both inflationary and very bad), or growth. Growth is the best option by far as real economic growth makes the overall economy larger than the size of the debt. For example, a couple with $60,000 in annual income and $20,000 in credit card debt is in a far worse position than a couple with $150,000 in annual income and $20,000 in debt. Productivity gains due to AI are theoretically very conducive to productivity gains and economic growth. If GDP can grow faster due to AI driven expansion and we can do more with fewer workers due to AI, there is a potential path out of the debt and demographic problems that the US and other developing countries are facing.
Another AI benefit is the augmentation of human intelligence. Consider what a Newton or an Einstein could do with the supercomputing powers that exist today. They would be able to postulate and test theories and iterate in a far faster and more efficient manner and pioneer new horizons far faster and far easier. At its present iteration, AI is incredible at saving time by sorting through data, exploring nuance and getting to a “trust but verify” state. If we are trying to find a needle in a proverbial haystack, I view AI as something that can shrink the size of the haystack by 90%. If our haystacks are 90% smaller, we can get through a lot of haystacks in a day.
Another AI benefit is efficiency and optimization. With AI we can take nearly any process and identify and improve chokepoints which leads to better outcomes. This done collectively across millions of individuals across entire economies aids capitalism’s efficient and optimized allocation of resources.
Lastly, like modern transportation, modern medicine, and modern communication and technology, AI has potential to improve the human condition and the quality of people’s lives. The ubiquity of cell phones for example, even in more impoverished areas, is creating opportunities and improving lives. AI has the potential to open doors and create opportunities that otherwise may not exist.
The Bad
Unfortunately, there is a potential dark side to the AI coin. I’ll list a few to illustrate this principle, but this list will by no means be exhaustive or complete.
One key risk to AI is the potential for groupthink and the dumbing down of human intellect. If this sounds like a contradiction of the prior statement about AI augmenting human intelligence, that’s because it is. Properly used, AI is an augmentation tool, an employee, if you will, to do mundane tasks to allow us to focus on higher objectives. Poorly used, AI becomes a crutch and replacement for critical thinking. As most AI models pull from the same sources and come up with remarkably similar outputs (anecdotally I’ve used most of the major model’s flagship offerings and they tend to align more than they disagree), using this in lieu of critical thinking can lead to herd mentality and a lack of creativity. Once one has incorporated AI into their life, it takes discipline to not outsource huge amounts of thinking to AI. Given that we humans aren’t always known for restraint and discipline, this becomes a very real concern for future generations.
Another key risk of AI is the degree of certitude in its responses and analysis. A virtue of AI is its confident, professional-sounding answers, but we can mistake this for a high degree of accuracy. I still will see AI miss basic principles that materially change answers. Over time, the quality of answers will continue to improve as will our ability to discern accuracy, but this does present a real risk. Perhaps even more importantly, however, is the quality of the source data going into these models. We’re all familiar with the term “garbage in, garbage out”, and this is a real risk. The collective wisdom of the internet isn’t grounded necessarily in fact and the quality of our AI outputs is only as good as the inputs which are often wanted. Sophisticated users do a good job of defining what trustworthy data sets to use in their AI activities.
Another potential AI issue is the suppression of human creativity. As a corollary to point #1, human advancement has been driven by curiosity, problem solving, and initiative. To the extent AI dulls these human impulses, we’ll fare far worse in the future.
There is also concern about AI being used for nefarious purposes and also concerns about the breakneck speed at which AI is evolving. Regulation and appropriate guardrails will have difficulty keeping up with the rapid expansion in scope and capabilities.
Lastly, there are widespread concerns about AI replacing human workers and displacing millions from the workforce. AI is truly a disruptive technology and disruptive technologies often cause “creative destruction”. On the one hand, humans are almost infinitely adaptable and adaptation due to new technologies is as old as time. Often claims of human displacement are overwrought, and the story of history is that of adjustments to new technologies. Those who adapt ultimately progress, while those who don’t tend to fall behind. On the other hand, AI is uniquely positioned to disrupt many of the jobs that the modern economy is built upon. Clerical and white-collar jobs are particularly vulnerable, and young people making career decisions have to ask the question, “how will AI affect this profession in the future?”. Potential social impacts here are significant and ideas like universal basic income will likely be debated in coming years.
Investor Impacts
AI has been impacting markets substantially and will likely continue to do so. The top technology companies, all of whom are heavily involved have seen a spectacular rise over the past several years:
These and other companies are making a bet of historic proportions that AI will be the future and are spending record amounts:
When we’ve had generational technologies in the past, we’ve seen huge capital expenditures (think telecom spending during the dot com boom) that have often been to excess and have seen subsequent industry consolidation. We don’t have any way of knowing if these capital expenditures are right sized, too small or excessive. If history is any indicator, however, companies will likely overshoot in spending and investors will likely overshoot in their enthusiasm. Those companies that emerge from this AI boom will likely richly reward their investors, but knowing which companies will survive and thrive is the answer to the proverbial $1mm question.
Our counsel to investors is to have appropriately weighted exposure to AI, but not to excess and to not neglect other holdings that comprise a well-diversified portfolio. We view AI as transformational and here to stay, but there are significant sums to be made by investors outside of AI and AI adjacent equities. This means there may be periods of time when AI is hot and those not all in on AI will potentially lag. However, if investors retain some AI exposure, this softens the degree of lag and in the event of a large AI pullback, diversified investors will weather the storm better. The dot com bubble is a cautionary tale:
To be sure, there are material differences between the dot com bubble and the AI revolution. Many dot com companies had little to no earnings while tech today is making more money than any group of companies in the history of the world. That being said, valuations are high and investors today are surprisingly cavalier about potential risks.
Conclusion
As we think about AI, it does us well to also think about other investment themes: huge geopolitical shifts (trade, wars, etc.), demographics trends (an aging developed world), sovereign debt concerns, and an overall shift of the global economic order. It does feel like we are at a historical inflection point and investment discipline is as important as it has ever been. Being diversified across geographies, asset classes, investment style (i.e. value vs. growth), and market capitalization (small, mid, large, and mega) is important during times like these where uncertainty is high and change is accelerating. Some investment fundamentals are timeless and worth repeating here:
- Have rainy day funds for emergencies
- Have sufficient funds in defensive buckets to meet withdrawal needs during market turmoil
- Recognize that market leadership continually changes and own a diverse set of assets
- Make sure your risk tolerance aligns with your investments and don’t panic when market turbulence arises
We wish each of you the best and a happy and safe summer season.
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