AI hype just collided with recession fears

Investors were already worried about how artificial investment will turn into profits. That’s being compounded by fears of a broader economic slowdown.

Aug 2, 2024 – 11.16am

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While we always lump the magnificent seven – Apple, Alphabet, Amazon, Microsoft, Meta Platforms, Nvidia and Tesla – together as tech stocks, there’s an argument that only three of them really fit that tag.

Tesla is a car maker, Amazon is mainly a retailer, Apple is a consumer goods company, and Alphabet, which owns Google, is an advertising and media company.

AI hype is mounting with some real-world problems. David Rowe

Now, all of this probably sounds like semantics – of course all these companies are powered by technology. But the alternative labels remind us that even these seemingly indestructible tech companies will be tested if the fabled soft landing for the US economy turns into something more nasty.

Those fears roiled Wall Street on Thursday night. Just a day after markets rallied hard on the prospect that the Federal Reserve will cut interest rates in September, investors were shaken by economic data that reminded the market that interest rates fall because economic growth is slowing.

Initial jobless claims in the US rose at the fastest rate in a year, while a key manufacturing activity fell further into contractionary territory, and to a level that has previously signalled a recession is coming.

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The Dow dropped 1.21 per cent, the S&P 500 shed 1.37 per cent, and the Nasdaq Composite slipped 2.3 per cent.

It was a nasty set-up for Apple, Amazon and a host of other tech firms – including big tech’s little Aussie battler Atlassian – to announce their June quarter results after the close of the market.

And on cue, investors hit the sell button.

Naturally, a key focus for all tech companies reporting on Friday was their artificial intelligence story – how much they are investing in AI, how they’re starting to monetise it, what customers are requesting. But there were several reminders that they aren’t divorced from what goes on in the broader economy.

Pain across the board

Apple delivered a strong set of numbers, returning to revenue growth in the June quarter, but its sales in China continue to fall and its iPhone sales went backwards, although at a slower rate than the market feared; the fact a new AI-powered iPhone is coming probably also weighed on demand.

While Apple shares were basically flat on the earnings report, Amazon shares dropped almost 7 per cent in after hours trade after it disappointed both on June quarter revenue and September quarter revenue guidance.

The problem? The macro environment, with shoppers trading down to cheaper goods.

“Customers continue to trade down on price when they can,” chief executive Andy Jassy said. “More discretionary, higher ticket items like computers or electronics or TVs are growing faster for us than what we see elsewhere in the industry but more slowly than we see in a more robust economy.”

Chief financial officer Brian Olsavsky even suggested consumer attention had been stolen by the Olympics and the Trump assassination attempt. Make of that what you will.

It was also a painful morning for Atlassian. Its shares, which are down 24 per cent year-to-date, plunged 13.4 per cent in after-hours trade after disappointing investors both on June quarter revenue growth and 2025 financial year guidance; the market had been conditioned for 20 per cent revenue growth over the next three years, but Atlassian is guiding to 16 per cent growth in 2025.

Co-chief executive and founder Mike Cannon-Brookes remains confident in the 20 per cent target over the next three years, but it was notable that there were plenty of references on the call to a more challenging macro environment.

There were other similar signs of pain across the tech sector. Intel shares plunged more than 18 per cent after it announced a $US10 billion cost-cutting program. Etsy shares fell almost 8 per cent due to weakness in the consumer sector.

The concerns about how the tech sector will navigate a weakening US economy were compounded by growing worries about whether the massive investment in AI infrastructure will deliver returns.

A matter of trust

The best example of this theme from Thursday night’s results was chip designer Arm. Its share fell 11 per cent in after-hours trade as the company explained how AI revenues work: the generative AI chips being made on Arm’s decisions will eventually deliver handsome royalties, but this process will take about four years.

Amazon said its capital expenditure bill for calendar 2024 would top $US60 billion as it geared up for this AI boom, but it was hard to get much of a sense how this would convert revenue, beyond Jassy repeatedly saying that just 10 per cent of enterprise IT has shifted to the cloud, and AI is likely to speed up this process, benefiting Amazon’s web services business.

Apple CEO Tim Cook batted away questions on the release of its AI-powered phones and laptops, saying developers are still working on features and apps. Fair enough. But once again investors are left taking AI gains on trust. At least Apple’s capex bill isn’t exploding like that of Amazon, Alphabet and Microsoft.

At the latter, capex is running at an annualised rate of $US80 billion ($123.2 billion). Microsoft demand for AI among its customers is exploding, but it still appears that most customers are in the experimental phase with the technology.

That’s hardly surprising given the world is still waiting to see how generative AI develops into a killer app. At present, its best use cases seem to be as an enhanced web search product, as predictive technology for completing sentences and software code, and as souped-up digital assistants.

Those are all cool, but are they game-changing? And there’s another question: will companies keep paying to experiment if a recession starts?

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