Is it time for value or will the AI-led growth cycle continue?

The AI investment boom continues to lift global equity markets, but fund managers are divided on whether the momentum can continue.

At the recent Meet the Managers conference held in Cape Town and Johannesburg earlier this month, some argued that the growth cycle remains intact, while others argued high valuations and rising uncertainty make a stronger case for value shares.

Rotation to value

A rotation away from growth stocks that dominate leading global indices to one that favours value stocks is already underway, Ziyaad Parker, senior portfolio manager for Indexation at the Old Mutual Investment Group, told the Meet the Managers conference.

Parker said value shares have begun to outperform as three forces are reshaping markets:

• Assets are moving away from the US dollar causing it to weaken relative to other currencies.
• Oil and energy dynamics are affecting supply chains and inflation.
• Higher inflation and interest rates to control it are undermining the earnings assumptions that supported growth stocks during the years of easy monetary policy.

Parker said many market capitalisation indices remain heavily exposed to technology shares that benefited from the growth cycle, but this concentration is a risk as the playbook shifts.
 

Long bear market in value

The value share bear market started in 2007 but ended in June last year, Parker said.

Value shares are now the cheapest they have been since the dotcom bubble in the early 2000s, which makes it a good time for value to perform going forward, Parker said.

Allocations to global equities need to be diversified. OMIG Indexation has therefore diversified its global equity allocations using the RAFI Fundamental Index which weights companies according to measures such as adjusted sales, book value and dividends and buybacks to capture exposure to value shares, Parker said.

It’s a gamechanger but we don’t love AI shares

Daniel Babkes, co-portfolio manager at New York-based Pzena Investment Management, told the conference value investors are not ignoring AI’s potential. The mistake, he argued, is assuming that belief in AI as a game-changing technology means investors should love all the AI-related shares currently driving markets.

After extensive fundamental research and discussions with company executives around the world, Pzena believes the commercial impact of AI remains unclear. Companies are spending unprecedented sums on infrastructure, while their ability to generate revenue opportunity is still being defined. This means the range of potential outcomes of this investment is very wide, he added.

Concentration is heavier than ever

Babkes said global markets are more concentrated in one theme than at any point he has seen, and valuations remain high by historical standards. Investors are therefore paying a high price for exposure to a narrow and uncertain opportunity.

He said two groups of companies are driving the market: the hyperscalers, including Amazon, Oracle, Alphabet and Microsoft, that are building large data centres for AI; and the semiconductor companies benefiting from that spending. The hyperscalers were already among the world’s most valuable companies, but their free cash flow is now being absorbed by data centre investment.

Trading at all-time highs

Despite this, their shares trade near all-time highs. Babkes said the market appears to believe the investment will pay off, partly because much of the new capacity is assumed to be sold. But he warned that some demand is linked to start-ups such as OpenAI and Anthropic, whose revenues remain small relative to the scale of their spending commitments.

Some technology companies are also raising equity and diluting shareholders to fund AI data centres that support customers without proven revenue models. Babkes said history shows that companies undergoing major capital investment cycles often perform poorly, except during periods when markets convince themselves of a powerful theme, such as the Nifty Fifty era or the dot-com bubble.

Pzena is therefore looking for company-specific opportunities that can offer attractive long-term returns and are less dependent on the broader market cycle.

Opportunities in the broader sector

The broader AI sector, however, continues to attract many other managers. Michael Jervis, portfolio manager of Sarasin, told the conference Sarasin is still investing in automation and digitisation as two of six themes it is backing. The others are changing consumption, goods and services for an ageing population, climate change, and security or defence.

Jervis says the equity market is slightly expensive and has been driven up by retail and high frequency traders. Sarasin does not believe it is sustainable. However, it creates investment opportunities for managers who can find companies that are growing faster than the market.

Sarasin has increased its equity exposure and reduced its bond exposure as it expects higher bond yields to weigh on bond prices. Jervis said inflation and strong GDP growth could support corporate profits and push equities higher. He added that while capital spending is high, Sarasin believes real revenue is being generated, and geopolitical risks have so far failed to derail equity markets.

Companies exposed to security and ageing are also expected to benefit from government spending on defence and welfare, he said.

Earnings and liquidity support growth

Flagship Asset Management, a boutique global manager based in South Africa that describes itself as style agnostic, also expects global equities to outperform other asset classes.

Philip Short, portfolio manager at Flagship, told the Meet the Managers conference that global equities are somewhat expensive, but remain supported by earnings growth and liquidity.

Short said earnings forecasts for the All Country World Index have increased 20 percent over the past 18 months.

Global liquidity, measured as the money held by individuals, corporates and governments for the 13 largest economies, is also rising rapidly.

It took 300 years for global liquidity to reach $100 trillion and then just five years to increase by another $20 trillion, he said. Because equity markets are closely correlated with liquidity, this remains a support for shares.

The main risk is higher commodity prices, which could keep inflation elevated and force interest rates higher, reducing liquidity and weighing on markets. AI may provide some offset if it proves disinflationary, as US Federal Reserve Bank Governor Kevin Warsh argues. Short said this remains uncertain but if AI lowers inflation, it would further support markets.