GQG Partners has recently reiterated its concerns regarding the artificial intelligence (AI) market, describing it as a “bubble on steroids” that could lead to significant repercussions for the S&P 500 if it bursts. In a timely discussion with Business Insider, Siddharth Jain, co-manager of the GQG Partners Global Quality Equity Fund, emphasized the potential downside risks tied to the current AI investment boom. He noted that a slowdown in AI capital expenditures (capex) could have profound implications, highlighting that over half of last year’s U.S. GDP growth was driven by AI-related spending.
Jain stressed that the current economic conditions reflect a fragile balance, particularly concerning income generation linked to the stock market. While GQG Partners has maintained a generally bullish stance on technology stocks since the firm’s inception in 2016—excluding 2021—Jain argued that the increasing likelihood of an AI market correction is too significant to disregard.
Several critical factors contribute to Jain’s cautious outlook on the AI trade. First, he pointed out that market valuations are alarmingly high, with projections suggesting unrealistic annual earnings growth in the low teens over the next three years. This kind of growth typically occurs following recession lows, which raises questions about current valuations, not only for public equities but also for private firms such as OpenAI and SpaceX.
Moreover, Jain highlighted the unsustainable levels of capital spending among hyperscale tech firms, which are now investing more capex per dollar of EBITDA than the energy and telecom sectors did at the peaks of their respective bubbles. This situation is compounded by the increasing leverage of these firms; many are expected to operate at negative free cash flow as they accumulate debt to fund their AI ambitions.
Jain cited Nvidia as a key player in what’s termed “circular financing.” This practice, where Nvidia enables its biggest customers to purchase chips by providing them with financing solutions, is not seen as a normal business operation and evokes memories of the telecom bubble.
In light of these risks, GQG Partners has adjusted its investment strategy, focusing on defensive stocks that are better positioned to weather a potential market downturn. In a recent report, the firm articulated its constructive view on defensive sectors, including healthcare, utilities, and consumer staples, asserting that these stocks are currently available at attractive valuations compared to the broader market—something not seen since 1990.
Jain emphasized that GQG does not base its purchases solely on market mean reversion but on an assessment of business quality and earnings durability. When discrepancies in valuation widen significantly, like they have now, there is a potential for normalization, although historically, markets do not normalize in a gentle manner.
In his interview, Jain also spotlighted three defensive stocks currently favored by the fund. The first is insurance firm Progressive (PGR), which he described as a high-quality investment at a low valuation relative to future earnings. He pointed out that it trades at only 12 times forward earnings, a level not seen since the peak of the dot-com bubble.
Philip Morris (PM), known for its tobacco products, was highlighted as the fund’s top investment, showing promising growth in its new product lines despite historical declines in tobacco volume. Jain noted that the company’s new offerings, like IQOS and Zyn, have led to a positive shift in market dynamics.
Lastly, utilities company American Electric Power (AEP) was mentioned as a sound investment, benefiting from a robust demand for energy and offering a 3% dividend yield, which enhances the overall return potential. Jain anticipates that AEP will experience accelerated growth in capital expenditures, projecting annual growth rates between 6% and 9%.
By seeking out these defensive stocks, GQG Partners aims to hedge against potential volatility while maintaining a commitment to long-term investment quality and sustainability in their portfolio.
