To my clients:

It was a mixed week for North American stock markets with the Canadian TSX finishing up 1.7%; the U.S. Dow Jones Index up 2.5%; and the U.S. S&P 500 down 0.1%.

Yes, it’s the first week of a new month and of course I’ll address the economic indicators so associated. But I’ll be much briefer than usual because I have something else on my mind today, and I’d like to spend some time discussing the ”other” matter.

On the “Big 3” economic indicators which, this week, happen to be just the “Big 2” because of a brief government shutdown that has - once again - prevented the release of the monthly Employment Report, we saw the ISM Manufacturing Index surge higher to its best reading in 3.5 years at 52.6 while the Non-Manufacturing Index (aka “Services”) held steady at its solid expansionary reading of 53.8. While other employment readings beyon the monthly Employment report continue to indicate a stagnating labor market, its nonetheless difficult to be overly negative about economic prospects when both ISM indices are printing solidly positive. It’s probably no coincidence that earlier today the Dow Jones Industrial Index crossed 50,000 for the first time in history (expect to read/hear/see much about this milestone in the news this weekend… in addition to the Super Bowl – Go ‘Hawks!).

But now, to what is really on my mind – technology and artificial intelligence (AI). It has been a very eventful week on a number of different fronts within the technology sector. I think I’ll break my discussion into the three interconnected topics of: 1) corporate spending to build out AI infrastructure; 2) the emergence – in the here and now - of tangible disruptions emanating from AI; and 3) from an investment perspective, where the AI buildout might be leading over the next 5 years or so (I’ll leave aside the longer-term philosophical discussions of what this all may mean for humanity).

So, what was already obvious over the past three years has come into even sharper focus the past two weeks – the HUGE corporate expenditures going into AI data center buildouts. For example, in their official earnings reports the following was reported: Meta (parent of Facebook) RAISED its 2026 AI spending estimate to $115 - $135 billion; Alphabet (parent of Google) RAISED its 2026 AI buildout estimate to $175 - $185 billion; Amazon RAISED its 2026 AI spending estimate to $200 billion; and, while Microsoft’s numbers a little bit more difficult to discern, it nonetheless is estimated to be well above $100 billion. Collectively, these four companies alone are expected to spend well in excess of half a TRILLION dollars on AI buildout in 2026 alone! These are staggering numbers and, to be clear, capital expenditures at these levels are unmatched in corporate history (even when adjusting for inflation). It rightly leads to questions about the sustainability of such expenditures and how long it will take these companies to realize a profit on such massive investments. This concern was one of two contributors to tech sector weakness earlier this week.

The other contributor to tech sector weakness was, perhaps paradoxically, the increasingly rapid step change improvements in AI technology. Anthropic, a private AI company, released its latest AI “coding agent” (essentially an AI powered software programmer) this week and its capabilities are, frankly, jaw dropping. The coding agent is called “Claude”. Deirdre Bosa, the lead tech reporter for CNBC, who has no coding/programming experience or knowledge, just three weeks ago used a prior version of Claude to develop a high functioning personal productivity tool (for herself) designed to scour ALL commentary by corporate CEOs in their quarterly earnings reports and analyze these CEO discussions for “BS” verbiage that is intended to perhaps obfuscate underlying concerns. I believe she called it her personal “Corporate BS Meter”. She developed this tool in under 1 hour using only a series of prompts written in plain English by herself. While not perfect, she said the result was nonetheless immensely impressive (and she demonstrated its use live on air) and that she would actually use it moving forward. Then, earlier this week, Ms. Bosa used the newest Claude release to develop an even more powerful productivity application that she felt was bordering upon being “enterprise ready” (meaning usable by major corporations for their internal operational needs) and this time did so in less than half an hour! While these developments are stunningly impressive and highlight the increasingly rapid improvements coming from AI (in this case, just 3 weeks between upgrades), the flip side is that these improvements are disrupting existing industries such as software development. Ever since ChatGPT first launched a bit more than 3 years ago, the share prices of software developers have been eroding with a growing belief that AI coding agents may make the sector obsolete. At first it was a slow ebb as these share prices declined, but this decline has accelerated as AI technology has simultaneously advanced and reached its fastest pace earlier this week. Unfortunately, the sale in software developer stocks spread to the broader tech community and led to a very rough week for tech stocks (i.e. the tech heavy NASDAQ stock market, which I don’t normally report th results of, was down 1.8% for the week). FORTUNATELY, client discretionary portfolios are well diversified across industries and withstood the tech sector declines very well (to wit, see the fact that the DOW crossed 50,000 for the first time ever!).

Now, while I don’t know if AI will lead to a complete obsolescence of the software industry, or if some companies will adapt and survive (I suspect the latter), it’s important to keep in mind that accelerating advancement in AI is going to lead to widespread productivity advancements across the economy writ large. In other words, the benefits are likely to significantly outshine the drawbacks. This is NOT the 2000 tech bubble meltdown on replay. While there are many differences between the two eras, I’d highlight the comments this morning by Nvidia CEO Jensen Huang who noted that the vast majority of fiber optic network cables laid in the late 1990’s were installed in anticipation of future high demand for the data capacity they offered, but remained initially “dark” (i.e. they were not being used because the demand for the capacity did not yet exist) and, further, a great many remain dark today (over a quarter century later!) Conversely, in spite of the hundreds of billions of dollars being spent on data center GPUs (i.e. the computer chips powering AI advancement), every single one of them is in use in the here and now. None are “dark”. And demand is accelerating; I know I am using AI ever more in both my professional and personal life and I’m sure the same is true of most people reading this update. As Mr. Huang stated, this is the largest infrastructure buildout in human history with the closest analogs being the development of the internet itself or the buildout of the U.S. Interstate Highway system which was integral in turning the U.S. into the economic behemoth it has become. But again, while much of the internet remained dark for years and decades after construction and the interstate highway system was, initially, sparsely trafficked, the AI data center buildout is fully utilized as soon as it is built. I am growing increasingly optimistic about the longer term (say the next 5 years or so) implications of this buildout – productivity is likely to surge. In the shorter-term, stock reaction will depend upon the ability of the aforementioned companies (you know, those four I mentioned spending over half a trillion dollars this year!) to monetize this spending in a way that boosts their revenues and earnings. The good news is, in the shorter-term, and as demonstrated in their recently disclosed quarterly earnings reports, these companies are indeed seeing accelerating revenue and earnings.

That’s it for this week. All the best,

Nick

P.S. Did I mention “Go ‘Hawks!”?

Nick Scholte, CIM, FCSI

Senior Portfolio Manager
RBC Dominion Securities Inc. │ Tel: 604.257.7569
2950 Glen Drive, 7th Floor │ Coquitlam, BC │ V3B 0J1
Toll Free: 1.844.665.9900 │Email: nick.scholte@rbc.com

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