301. The opportunities and challenges of AI

15 February 2024 (pre-recorded 14 February 2024)

Below is a transcript of the episode, modified for your reading pleasure. Please check the corresponding audio before quoting in print, as it may contain small errors. Please remember we’ve been discussing individual companies to bring investing to life for you. It’s not a recommendation to buy or sell. The fund may or may not still hold these companies at your time of listening. For more information on the people and ideas in the episode, see the links at the bottom of the post.

[INTRODUCTION]

Staci West (SW): Welcome back to the ‘Investing on the go’ podcast brought to you by FundCalibre. We cover a lot of key topics in today’s interview from the S&P 500’s all-time high earlier this week to supply chain dynamics, the success of Nvidia and Microsoft through to luxury goods and the Asian consumer.

James Yardley (JY): I’m James Yardley, and today I’m joined by Dave Dudding, the Elite Rated manager of the CT Global Focus Fund. Dave, thank you very much for joining us today.

Dave Dudding (DD): Thank you, James.

[INTERVIEW]

JY: Now, Dave, I mean, it’s been a very interesting start to the year. We’ve just had the S&P 500 going through 5,000 for the first time. I know your fund is a global fund, but it does have a substantial weighting in the US – so, where are we for our listeners now? I mean, obviously we’ve had a very strong run for the S&P the last few months – I think we’re up about 20% or so – how are you thinking about the market from here? Is it looking good value and is there further to go or is it time to [start] being a bit more defensive perhaps?

DD: Well, to be honest, James, we’re not very good at market timing. So, a year ago I think we all felt that 2023 was probably going to be a bad year for the stock market and that the US economy was going to flirt with recession, and actually GDP growth was tremendously strong and stock markets did incredibly well. So, our track record at sort of macro-forecasting isn’t great, and I always think it’s best just to try and focus on the things that we as investors know about – or at least think we know about – which is the prospects for individual companies.

I really think it’s very, very difficult to try and [time the market] … market timing is very, very difficult and it can be very expensive for investors as well if they think that markets are expensive and then they miss out on significant rallies, then time out of the market is very expensive. So, irrespective of the market moves at the moment, we still think that there are some great opportunities in the medium to long-term. And as to what the stock market does this year, I’m afraid I couldn’t really tell you.

JY: No, I mean, fair enough. I mean, of course I think your strategy is known for being more of a bottom-up style. I think you are more focused on finding the highest quality best companies from the bottom-up and then owning them for a good amount of time and letting them compound. What are you hearing from your companies on the ground at the moment? Are they in pretty good shape? And what are they saying in terms of supply chains, the inflation outlook and some of the things which have been dominating the headlines recently?

DD: It’s sort of pretty mixed to be honest. And I think it very much depends on what you do. So in terms of supply chains, I think those have definitely normalised. There’s obviously been a few scares in the past month or so about sort of traffic in the Red Sea because of the situation in the Yemen and obviously in Gaza, but they seem to be pretty mild. So, from a supply chain situation, things have sort of more or less normalised. But now you do have this period where basically, I think, companies are prioritising security of supply over and above sort of efficiency. And that does mean you’re seeing a move away from China, for example, partly, which was happening anyway, partly because, you know, China’s become fairly expensive for many things. And obviously, I think the world has woken up to the fact that the vast majority of the world’s semiconductors are manufactured in Taiwan and South Korea and strategically, that’s not ideal. So there is this sort of broader move, I think, towards nearshoring and possibly reshoring, but also, in terms of things like semiconductors, there’s obviously a lot of stimulus on the parts of European, US and even the Japanese government to try and encourage localisation of semiconductors’ supply chains to an extent.

So, supply chains are sort of normalising in the short-term, but some changing patterns in the medium-term. And some companies that we invest in I think can very much benefit from those changing supply dynamics in terms of inflation coming down, partly because those supply chain bottlenecks have sort of almost entirely disappeared. But I think what has maybe been a bit more persistent than people were thinking was wage inflation. So, labour is in pretty short supply in many parts of the world. Obviously pressures against immigration as well. And so wage increases have been quite high and I think that will take sort of longer to quieten down. So, we are still pretty much proponents of the higher rates for longer and inflation may prove slightly sticky or stubborn at around about these levels. So, I think some of the great optimism there was a month or two ago about interest rates coming down very quickly in the States, I think in the last few days that’s been dampened somewhat.

But that said, the US consumer is in reasonable shape. I think you’ve got pretty much full employment and you’ve had some quite nice wage increases. So the US consumer’s in a fairly healthy position; the US economy, if anything, has been too strong. So, you know, net net, I think things are not too bad, but it can be quite patchy. So you know, there are pluses and minuses everywhere.

I think one of the other big drivers, obviously of markets in the last sort of year or so and again in the early part of this year, has been the development of AI as a theme. And really there have been some great numbers coming out of the tech sector some of which is, you know, largely driven by AI. And again, a sort of normalisation after a period where spending on the cloud, for example, was slightly depressed, and that now seems to be coming back. So those sort of drivers are almost happening irrespective of actually the macro-outlook.

Meanwhile, you’ve got sort of areas where the US housing market is still fairly subdued. I mean, we think it’s sort of bottoming and there are some signs of life in residential construction, for example, but life’s still fairly tough there. So, the picture’s a bit mixed. And it sort of depends on where you are geographically, but on the whole we do see inflation coming down and at some point we think that we will start to see some interest rate cuts certainly in the US, possibly in Europe, but at the same time, Japan actually, you are more likely to see rates going up. So, the story’s a bit different depending on which part of the world you are looking at.

JY: So, let’s maybe dig into some of those things a little bit more. So, I mean, you mentioned AI, which is obviously very topical at the moment. How are you thinking about this? I mean, has it caused you to change the portfolio at all? Are there any ideas you are particularly excited about or is it all getting a bit frothy at the moment? I mean, what are your thoughts?

DD: Well, basically, we’re quite lucky in that I think we were sort of believers in AI as a theme relatively early so we’ve had a position in Nvidia, which is obviously the biggest beneficiary, for quite some time. We’ve had big positions in Microsoft and Alphabet as well, so, we are believers in in AI, although in some ways we see it really as a continuation of an existing sort of trend. But much now depends on the success of ChatGPT amongst other products. So, we’ve had a lot of initial enthusiasm and, I guess, now we’re in a phase where we really need to start to see that coming through in the company numbers.

JY: It’s certainly coming through for Nvidia, isn’t it? I mean, although the share price is up so much, I think the multiple, if anything, has pretty much stayed the same or maybe even come down slowly. So, of course, we get to see it, I think, as you were saying, to the wider product and universe.

DD: Well, that’s why the easiest way to invest at the moment in AI has been semiconductor supply chain. So Nvidia is by far and away the biggest beneficiary. But you’ve also seen sort of some other companies like AMD [Advanced Micro Devices, Inc.], Marvell [Technology, Inc.] and then the semiconductor capital equipment manufacturers ASML, LAM [Research Corporation], Applied Materials, Tokyo Electron the other day – all these companies are certainly the big cloud companies and Nvidia are certainly ordering large amounts of chips. So that has been the easiest way to play the theme. And one of the reasons we were so bullish on Nvidia was last year, as you said, the stock went up 250% but the earnings forecast went up by more than that, so actually the stock de-rated, which is fairly hard to fathom of a company that size, but forecasts at around about this time last year, they massively beat and then they had a succession of earnings forecasts where they kept beating very, very significantly. And again, the stock was up, you know, well over 200% last year. It’s now up another 50% in the early days of this year. So these are fairly extraordinary moves.

We haven’t seen the numbers from Nvidia yet for Q4: they’re going to be pretty good. But, as ever, we’re in a position of travelling and arriving, I guess, and some of this move has probably been priced in. So, for the last few quarters, Nvidia has had great results and the stock has actually probably gone down or drifted sideways for a while as people take profits. So, you know, it’ll be interesting to see what the reaction is. I think people are not worried, but it is more … we know that 2024 is going to be a great year for Nvidia, so I think the debate is more about 2025 and also about increasing – or the potential for – increasing competition as well from other companies. So, we’re big believers in the story, but you know, we have to temper that with a degree of realism, I think it’s fair to say.

JY: Yes. I mean, I think what’s just scary is just the numbers are getting so big now. I think you’ve got to question how sustainable it is, but it sounds like you still think there’s further to run with it, even though I think – I don’t know what the market cap for Nvidia is now, it’s changing by the minute, probably we’re getting towards 2 trillion [US dollars] or something now, it’s…

DD: Bigger than Amazon now.

JY: Yes.

DD: Fairly incredible.

JY: [And] it does feel as if surely those numbers are unsustainable or maybe the opportunity just is that big. I don’t know.

DD: Well, there’s always the difference between the short term and the long term. And over the next five or six years, we do believe that this will be a powerful theme.

JY: And what else are you really excited about in the portfolio away from AI?

DD: I’m excited about everything in the portfolio, otherwise it wouldn’t be in there! So, you know, [JY: Give us some of those best companies then] Well, we do have Microsoft, you know, which is our biggest holding, I think is on a more palatable valuation than Nvidia, for example. And yet obviously, it’s very well positioned I think for the rest of the decade.

JY: So is that on the cloud? Is that mainly why?

DD: It’s largely because of the cloud, yeah, so it’s one of the big three cloud providers and basically it’s gaining market share. And because of its relationships with corporates, it’s in a very, very strong position to benefit from that continued move to the cloud as well as spending on AI. So yeah, we do think it’s well-positioned. Even within things like security for example, you know, they’ll be beneficiaries of increased spending on that as well. And this is an industry with relatively high barriers to entry as well so Microsoft is doing very, very well and you know, continues to be in a net cash position, so the balance sheet is very strong and it has a lot of recurring demand. You know, a lot of its sales and profitability are recurring in nature, so it’s a great business and we still think it’s very attractively priced.

I guess, you know, some of the other things that people are interested in are always GLP-1s. So the sort of the weight loss drugs developed by Novo Nordisk and Eli Lilly – we’re holders of Lilly. Simply, you know, we were holders of Novo as well, but we decided just to have one name in the space. But we are, you know, quite big believers there as as well. And, it’s important to highlight, these stocks have done incredibly well as well. I mean, they are the sort of Nvidia equivalent of the pharma industry. So again, there’s quite a lot priced in, but we do think that these drugs are going to take off. The barriers to entry are fairly significant in terms of the manufacturing which is very, very difficult and capital intensive. So, there is set to be good growth in this field for a number of years to come.

We’re still longer term big believers in the rise of Asian consumers – half of world’s population lives in Asia, people are getting richer. So, you know, we’re still looking for ways to sort of invest there.

And hopefully, you know, the sort of energy transition, we’re also big believers in stocks that can help with that, and in particular with electrification. So, companies like Schneider Electric, which is a French multinational with big positions in the US and also China, we see that as being a big beneficiary of those sorts of themes. And again, they’re supplying data centres, for example, so a lot of that comes back to Microsoft, Alphabet, Amazon and spending patterns there. But it is a bit broader as well because Schneider are also benefiting from investment in the grid in particular around the world really, as you need to spend more money on the grid to store and distribute electricity, particularly as more and more is derived from renewable sources.

So, there’s still quite a lot of sort of exciting places to be, I think.

JY: Yeah, it sounds like there are lots of exciting ideas in the portfolio. So, how are you playing the Asian consumer? Are you looking to play the rise of India and do you worry at all about the geopolitical risk there? I guess obviously some investors are quite nervous about China now – do you still think there’s opportunities there?

DD: Well, we’re quite underweight China and conversely, we probably prefer India, but you can get a lot of exposure to the Chinese economy and the Indian economy through luxury goods companies, for example, or even consumer staples. A lot of businesses have exposure there. So you know, we own names like L’Oreal for example, which is doing very, very well but China has been a bit of a disappointment to them, certainly in the last quarter of the year. Conversely, luxury goods companies actually did much better than expected in the last quarter of the year. So, we own LVMH, but Hermès, Ferrari, these sorts of businesses continue to do very well in areas like the Middle East and the Far East, where basically there’s a lot of wealth creation going on and these names are big beneficiaries of those trades.

JY: Brilliant. Well, thank you very much for joining us today, Dave.

SW: CT Global Focus is a concentrated, high conviction portfolio of best ideas. This is a genuine global fund which will then turn to emerging markets but only when it can find businesses that can meet its strict quality criteria. For more information on the CT Global Focus fund, visit FundCalibre.com, and don’t forget to subscribe to the Investing on the go podcast, available wherever you get your podcasts.