The world of one trade — AI

AI was the hot new investment theme once — a shiny opportunity for money managers of all sizes willing to put their capital to work in a transformative technology.

It still is that, sort of, if you look past the warnings of a robot apocalypse, the destructive “rogue” hacking agents that increasingly look more like a feature than a bug, and the legal risks starting to circle around the AI labs. (“Oops, our agents did it again” is wearing thin as an excuse.) Despite all that, no one can reasonably doubt the once-in-a-generation moneymaking capabilities of the ecosystem, from chips to data centres, and that’s the bit that professional investors are paid to think about.

But the AI trade is no longer new and it is no longer “a” theme. Instead it has morphed into “the” theme — a vast, suffocating blob slathered on top of the global financial system, starving everything else of oxygen, distorting market reactions and leaving every portfolio, everywhere, alarmingly reliant on the fortunes of just one bet. Stocks, real estate, infrastructure, energy, emerging markets, some vintages of private equity . . . they’re all, to a large extent, the same trade.

The sheer dominance of this thing over global stocks was on emphatic display this week. The oil price continued to smoulder at $100 or so a barrel, and traders again fired up their warnings that logistical constraints in the Strait of Hormuz opened up a very real chance of a push to $200. Bond prices were stuck in the deepest rut in decades, with the 10-year benchmark US government bond yield — the borrowing cost that stands as the most important number in global markets — wedged comfortably above 5 per cent. Either or certainly both of these things would usually pull stock markets lower.

Not a bit of it. Instead, the S&P 500 index of US stocks hit a new record, as did the tech-heavy Nasdaq. We’re all by now accustomed to a little market dissonance, but this is, at a minimum, extremely odd.

Slicing up indices in weird and wonderful ways to suit a narrative is cheating. But we need to do it anyway to understand what is going on. So, yes, the S&P is at a record. But if you strip the AI component out of the index, the remaining rump has dropped by 7 per cent since the end of August. You get a similar picture if you look at the S&P on an equal-weighted basis, which helps to smooth out the oversized impact of enormous tech stocks. The gap between the top-heavy typical index and its more even-handed cousin is not new, but it has now reached its widest point in nearly 24 years. Three-quarters of the stocks in the S&P fell last month — tech stocks and the energy stocks that reflect the data centre build-out really are doing all the work.

Who cares? A lot of people don’t, as long as the line on the index goes up. The problem is that professional investors are struggling to figure out how to diversify properly, how to shield themselves if something goes wrong — a crucial part of their task in managing other people’s money. Many are spooked by just how correlated portfolios turn out to be across a range of supposedly diverse asset classes.

For now, the whole world is all-in. Non-US money has funnelled into dollar-denominated assets at an extraordinary pace over the past decade, and increasingly, it is not even hedged for currency risk. In other words, the AI boom has almost by accident become a major prop not just for the US stock market but for the dollar too.

Without question, US corporate earnings, not only in tech but especially in tech, justify the excitement. If anything, US stocks are pretty cheap right now — stock prices have not kept pace with spectacularly rapid earnings growth, seemingly held down in part by rising bond yields.

But we still, collectively, have a very poor read on how AI will pan out. To some extent, everyone is guessing here, but private equity firm Bain said in a recent report that annual spending on AI infrastructure could reach $1.5tn by 2031. Extraordinary stuff. Even more extraordinary, though, it added that “sustaining this level of investment would require an AI market approaching $6tn annually”. Really? An industry worth one-and-a-half times the UK’s entire annual economic output every year? This is struggling to pass the smell test.

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Policymakers seem uncertain what they are dealing with here too. US Federal Reserve chair Kevin Warsh has been of the view that the productivity stemming from the use of AI will, fairly quickly, pull down inflation. But others at the central bank, recently including Mary Daly and Lisa Cook, are veering towards an opposing view, that the build-out poses an upward risk to inflation in the months ahead.

So we’re left with a strikingly two-speed US stock market beloved of pretty much every investor on the planet, dominated by an AI build-out that is, in practical terms, nearly impossible to hedge or avoid. We don’t really understand the long-term economic implications, but the underlying commercial assumptions seem rather heroic. And we’ve all, deliberately or otherwise, hitched our fortunes to the idea that it will work out just fine. We’d better be right.

katie.martin@ft.com