Shares of artificial intelligence (AI) chip names Broadcom (AVGO +0.18%), Taiwan Semiconductor Manufacturing (TSM +1.32%), and Arm Holdings (ARM +16.38%) were falling on Wednesday, down 6.7%, 5.1%, and 7.7%, respectively, as of 3:28 p.m. ET.
None of these companies reported news today, but the entire artificial intelligence chip cohort seemed to be taking it on the chin after tech giants Alphabet and Tesla reported earnings last night that failed to live up to expectations.
The technology giants in the "Magnificent Seven" tend to be the biggest customers for artificial intelligence chips, so any sort of weakness at these companies could be thought of as a danger to future AI spending -- even though there's no evidence of a letup today.
NASDAQ: AVGO
Key Data Points
Alphabet and Tesla keep spending, but investors wonder about the results of it all
Last night, Tesla reported earnings that were mixed, with revenue slightly beating low expectations, but non-GAAP (adjusted) earnings per share missing the mark. Tesla has been experiencing well-known struggles as EV sales have slowed and its brand has come under question. Meanwhile, Alphabet actually beat both revenue and earnings expectations. Strength in Search and Cloud was offset by a slight miss on YouTube growth. Still, that beat was apparently not good enough for investors, who had bid the stock up over 30% this year, even after today's decline.
What does this have to do with these three chipmaker stocks? Well, both Tesla and Google are spending lots of money on Nvidia GPUs, which are produced by TSMC. Nvidia's Grace CPUs that sometimes accompany its GPUs in its "super-chips" are also built on the Arm architecture, and thought to be a big growth driver for Arm. Meanwhile, Google also makes its own accelerator chips called Tensor Processing units, which utilize Broadcom's custom ASIC IP. Google also came out with its own in-house-designed Arm-based CPU called Axion back in April.
So, these chip stocks will do well if the big tech giants keep investing in AI. That means any softer-than-expected result could lead investors to believe that AI investment isn't paying off just yet, and may not continue at these levels. Tesla, for its part, while increasing research and development (R&D) and capital expenditures on a year-over-year basis, actually decreased spending in both categories relative to the first quarter.
But CEO Elon Musk noted that could be due to supply constraints. On the conference call with analysts, he noted:
I'm incredibly impressed by Nvidia's execution and the capability of their hardware. And what we are seeing is that the demand for Nvidia hardware is so high that it's often difficult to get the GPUs. And there just seems this -- I guess I'm quite concerned about actually being able to get [a] steady amount of Nvidia GPUs and when we want them.
Meanwhile, Alphabet continued spending heavily on capital expenditures for AI data centers, with its capex nearly doubling relative to the prior year and up 10% quarter over quarter. CEO Sundar Pichai noted on his conference call Alphabet will continue to spend on AI:
We are at an early stage of what I view as a very transformative area and in technology, when you're going through these transitions, aggressively investing upfront in a defining category, particularly in an area in which in a leveraged way cuts across all our core areas or products, including Search, YouTube, and other services, as well as fuels growth in Cloud and supports the innovative long-term bets and Other Bets is definitely something for us makes sense to lean in. I think the one way I think about it is when we go through a curve like this, the risk of under-investing is dramatically greater than the risk of over-investing for us here, even in scenarios where if it turns out that we are over-investing ... these are infrastructure which are widely useful for us. They have long useful lives, and we can apply it across, and we can work through that.
Given all this positive commentary on AI spending, why might the chipmakers be down? One might have thought they'd be up given these comments.
Image source: Getty Images.
While current commentary is strong, investors appear to fear the good times may not last. Google seemed to give a conservative commentary for YouTube, and while Cloud and Search were strong, some may have wanted to see an even bigger payoff sooner.
Furthermore, macroeconomic concerns are looming. Today, in an opinion piece in Bloomberg, former Federal Reserve President Bill Dudley advocated for an interest rate cut at the July Fed meeting, in order to stave off a recession. According to Dudley, inflation has fallen and the labor market has come more into balance to the point where waiting until the September meeting to cut interest rates risks being too late.
Investors had until now assigned a low probability to a July cut, so it's possible Dudley's piece may be setting off alarm bells. Certainly, a recession would hurt big tech giants' revenue and profits, and could certainly curtail AI spending, too.
But this seems like an opportunity
While there may be near-term worries over the economy and investors nit-picking big tech results, all the commentary from tech giants around AI's transformative possibilities remains positive. Tech giants, even in a mild recession, still have tons of cash, and don't want to risk being left behind over the coming decade.
Therefore, investors with a time horizon beyond this quarter should perhaps view this pullback as an opportunity to buy or add to some of these names. If you were a believer in the AI revolution before today, nothing in this pullback should change that story.
