What a difference a few months can make: In 2022, Wall Street closed the books on its worst year in more than a decade. In fact, the major market indexes posted their worst performance since the bear market of 2008.
Now, just months later, things appear to have turned a corner. All three major market indexes have climbed more than 20% since their recent troughs, with some market watchers calling it the beginning of a new bull market.
What caused this abrupt turnaround? In a nutshell: recent developments in artificial intelligence (AI). The emergence of ChatGPT late last year highlighted the potential wide-ranging applications for generative AI, which acted as a catalyst for the current market exuberance.
While some investors fear the recent rally has come too far, too fast, Wedbush Securities managing director Dan Ives thinks this could be just the beginning. While many stocks are positioned to benefit from the ongoing AI arms race, Ives highlights two stocks with the most to gain.
Image source: Getty Images.
Is history repeating itself?
For some investors, the recent stock market rally and increasing valuations are reminiscent of the dot-com bubble that started in the mid-1990s. Many technology stocks raced to new all-time highs, fueled by the internet boom and lofty expectations of things to come. That bubble eventually burst, causing those same stocks to plunge.
The similarities to the current situation are striking. This is causing some market participants to fear the worst and suggesting the recent run-up isn't sustainable, setting investors up to take a fall.
Ives, however, has a much different view. The Wall Street veteran suggests this is just the beginning. "While it's been a strong year for the tech sector we believe a broader rally around software, chips, and Big Tech could be on the horizon as we expect the tech sector to be up another 10% [to] 12% in [the second half]," Ives wrote in a note to clients. Furthermore, he believes generational AI has sparked the "fourth Industrial Revolution," resulting in a rally that could continue for years (emphasis mine).
He went on to say:
While many of the tech skeptics will point to today as a "1999 moment" ala on the verge of the dot-com bubble/collapse, given the significant move in tech valuations, we strongly disagree. The massive $800 billion AI opportunity (our estimate) is now on the doorstep for the tech sector for the next decade, and real monetization of AI is happening much sooner than expected.
Ives also has strong opinions about the biggest beneficiaries of the current environment.
Poised for greater success
While he acknowledges that "many will benefit," Ives identified two "clear market leaders" set to prosper over the coming decade.
First up is Microsoft (MSFT +1.65%). The enterprise software giant arguably helped ignite the ongoing AI revolution after it confirmed a $13 billion investment in ChatGPT parent OpenAI and announced plans to integrate its generative AI capabilities into its search engine and across its top-tier Azure cloud.
NASDAQ: MSFT
Key Data Points
The company has since debuted Azure OpenAI service and added support for ChatGPT to its cloud service, while simultaneously expanding its new AI-powered Bing search. Microsoft also introduced a host of new tools that will help developers integrate AI into their own apps.
The other clear winner is Nvidia (NVDA 0.09%). The company struggled during much of the recent downturn, the result of sluggish demand for its high-end graphics cards used by gamers. Late last month, management stunned Wall Street when Nvidia provided guidance for its fiscal 2024 second quarter (which ends July 31), forecasting revenue of roughly $11 billion, up 64% year over year and 53% sequentially.
CFO Colette Kress cited surging demand by "large consumer internet companies and cloud service providers" for the specialized processors used to facilitate generative AI. CEO Jensen Huang believes the accelerating adoption of accelerated computing and generative AI will result in a $1 trillion opportunity within the global data center market.
NASDAQ: NVDA
Key Data Points
The usual caveats
Let's be clear: A near-term stock market decline is an ever-present possibility. Furthermore, the valuations for both of these AI leaders have soared so far this year. Microsoft is currently selling for 35 times forward earnings and 11 times next year's sales. Nvidia's price tag is even more startling, at 55 times earnings and 20 times sales.
However, valuation shouldn't be viewed in a vacuum. If Ives is right -- and I, for one, am totally on board with the long-term thesis -- each of these industry leaders could run for years. While their valuations might seem stretched now, the disruptive power of AI could truly be a true game changer, fueling a meaningful surge in both revenue and profits, allowing them to grow into their valuations and fueling a rally that could last for much of the next decade.
If valuation is still a concern, consider buying a small starter position in each of these stocks and add to it when the valuations inevitably improve.
