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Third Quarter 2023 Newsletter

Salal Investment Services

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Adrian A. Hedwig

Financial Advisor, CUSO Financial Services, L.P.*
Available by appointment at all Salal Credit Union branches.
Virtual and phone meetings also available.
P: 206.607.3481
F. 206.299.9530

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Pacific Northwest Coast Landscape

Quarterly Market Review:
April – June 2023

The Markets (through June 30, 2023)

Wall Street proved resilient during the second quarter of the year, despite rising inflation, two interest rate hikes, and concerns about the debt ceiling. The economy remained relatively strong, despite predictions that it may be headed toward a recession. The second quarter saw information technology, communication services, and consumer discretionary account for most of the market gains. Energy, utilities, health care, financials, and consumer staples slid lower. The market’s positive performance during the second quarter was buoyed by strength in the labor market, economic data that may be showing inflation is beginning to wane, and a better-than-expected first-quarter gross domestic product.

Government bond yields rose in the second quarter, with investors eyeing the relative strength of the economy as reason to remain bullish on stocks. Each of the benchmark indexes listed here climbed higher in the second quarter, with the Nasdaq enjoying its third-best first half on record, a far cry from last year at this time, when the tech-heavy index was going through its second-worst six-month stretch. The S&P 500 also enjoyed notable growth in the second quarter. The dollar inched higher while gold prices retreated in the second quarter. Notwithstanding a roughly 4.0% increase in June, crude oil prices declined for the fourth consecutive quarter, marking the longest losing streak since 1988. While indications seem to point to a more bullish outlook, crude oil supply continued to outpace demand, muting prices. OPEC+ cuts were offset by production increases from other sources, including the United States. In addition, China’s demand has been weaker than anticipated, with manufacturing slow to expand. Prices at the pump rose in the second quarter. The June 26 retail price for regular gasoline was $3.571 per gallon, $0.15 above the March price of $3.421 per gallon. However, gas prices are down $1.301 over the last 12 months.

April began the quarter with stocks posting modest gains from the previous month. The large caps of the Dow (2.5%) and the S&P 500 (1.5%) were bolstered by a rally over the last two days of the month. Small caps declined further with the Russell 2000 falling 1.9%, while remaining marginally ahead of its 2022 year-end value. Among the market sectors in April, industrials underperformed, while communication services fared the best. Data in April showed some signs of economic weakening. Job growth in April (236,000), was well below the monthly average for the year, while the number of workers receiving unemployment insurance reached its highest level since November 2021. Housing data was soft, with the number of residential building permits and housing starts sagging from the previous month. Existing home sales dropped, while the median existing-homes sales price was 0.9% less than a year ago. Financials took a hit after another bank fell into Federal Deposit Insurance Corporation receivership. Despite some economic downturns, other data supported ongoing economic strength and bolstered investor sentiment. First-quarter corporate earnings were somewhat better than expected. The Consumer Price Index inched up only 0.1%, bringing the year-over-year increase to 5.0%, the lowest annual pace since May 2021.

Stocks were mixed in May, with information technology and communication services pushing the Nasdaq up nearly 6.0%, while the Dow lost 3.5%. The S&P 500 inched up 0.3%, but the small caps of the Russell 2000 fell 1.1%. Like the previous month, relatively strong corporate earnings reports and encouraging inflation data helped keep investors in the market. Bond prices slid lower, pushing yields higher, with 10-year Treasuries climbing 18.0 basis points in May. Stocks began the month on a downturn after the Federal Reserve hiked interest rate 25.0 basis points, while giving no clear indication as to whether or when more rate hikes were coming. For much of the month, investors focused on the debt ceiling negotiations between President Biden and House Speaker McCarthy. Mega-cap technology and artificial intelligence stocks dominated the market for much of May. Inflation remained elevated, with the personal consumption expenditures price (PCE) index, a preferred inflation indicator of the Federal Reserve, rising 4.3% for the year, while consumer prices excluding food and energy rose 4.7%.

June was a strong month for stocks, with each of the benchmark indexes listed here posting gains of between 4.6% and 8.0%. Inflationary pressures showed signs of cooling, with the 12-month PCE price index coming in at 3.8%. The Consumer Price Index rose 4.0% for the year, the smallest 12-month increase since the comparable period ended March 2021. The Federal Reserve elected not to increase interest rates in June, opting, instead, to step back and assess additional information and its implications for monetary policy. Gross domestic product advanced at a stronger-than-expected 2.0% for the first quarter, showing resilience in the economy. Despite the collapse of several major U.S. banks, the Federal Reserve indicated that the largest domestic banks are sufficiently positioned to continue lending to households and businesses even during a severe recession. The labor market picked up the pace, adding nearly 340,000 new jobs, in line with the average monthly gain over the past 12 months. Industrial production declined minimally, following two consecutive monthly increases. While manufacturing slowed, business activity in the services sector expanded at the fastest rate since April 2022. Long-term bond yields increased in June from May, as bond prices dipped lower.

Stock Market Indexes

2022 Close
As of June 30
Monthly Change
Quarterly Change
YTD Change
S&P 500
Russell 2000
Global Dow
Fed. Funds
4.25% – 4.50%5.00% – 5.25%0 bps25 bps75 bps
10-year Treasuries
3.87%3.81%18 bps32 bps-6 bps
US Dollar-DXY
Crude Oil-CL=F
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.

Latest Economic Reports

  • Employment: Employment rose by 339,000 in May from April, in line with an average monthly gain of 341,000 over the prior 12 months. In May, employment continued to trend upward in professional and business services, health care, government, construction, transportation and warehousing, and social assistance. The unemployment rate rose 0.3 percentage point to 3.7%. In May, the number of unemployed persons rose by 440,000 to 6.1 million. The employment-population ratio, at 60.3%, and the labor force participation rate, at 62.6%, were little changed from the previous month. Both measures have shown little net change since early 2022. In May, average hourly earnings increased by $0.11, or 0.3%, to $33.44. Over the past 12 months ended in May, average hourly earnings rose by 4.3%. The average workweek edged down 0.1 hour to 34.3 hours.
  • There were 239,000 initial claims for unemployment insurance for the week ended June 24, 2023. The total number of workers receiving unemployment insurance was 1,742,000. By comparison, over the same period last year, there were 213,000 initial claims for unemployment insurance, and the total number of claims paid was 1,340,000.
  • FOMC/interest rates: The Federal Open Market Committee maintained the federal funds target range rate at the current 5.00%-5.25% in June. The Committee essentially decided to assess the effects of prior rate increases. However, the FOMC indicated that more rate hikes are likely, noting that inflation remained elevated, while economic activity expanded at a modest pace and job gains have been robust. Overall, the FOMC will base its decisions on available data, and “will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments.” The summary of economic projections has the federal funds rate at 5.6% in June from 5.1% in March, which suggests the fed interest rate will be increased by 50.0 basis points by the end of 2023.
  • GDP/budget: Economic growth slowed minimally in the first quarter, as gross domestic product increased 2.0%, according to the third and final estimate from the Bureau of Economic Analysis. GDP rose 2.6% in the fourth quarter. The deceleration in first-quarter GDP compared to the previous quarter primarily reflected downturns in private inventory investment and residential fixed investment. Consumer spending, as measured by personal consumption expenditures, rose 4.2% in the first quarter compared to a 1.0% increase in the fourth quarter. Consumer spending on long-lasting durable goods jumped 16.3% in the first quarter after decreasing 1.3% in the prior quarter. Spending on services rose 3.2% (1.6% in the fourth quarter). Nonresidential fixed investment increased 0.6% after climbing 4.0% in the fourth quarter. Residential fixed investment fell 4.0% in the first quarter, significantly better than the 25.1% decrease in the fourth quarter. Exports increased 7.8% in the first quarter, following a decrease of 3.7% in the fourth quarter. Imports, which are a negative in the calculation of GDP, increased 2.0% in the first quarter after declining 5.5% in the previous quarter. Consumer prices increased 4.1% in the first quarter compared to a 3.7% advance in the fourth quarter. Excluding food and energy, consumer prices advanced 4.9% in the first quarter (4.4% in the fourth quarter).
  • The federal budget had a $240.3 billion deficit in May, well above the May 2022 deficit of $66.2 billion. The deficit for the first eight months of fiscal year 2023, at $1,164.9 trillion, is much higher than the $426.2 billion deficit over the same period of the previous fiscal year. In May, government receipts totaled $307.5 billion for the month and $3.0 trillion for the current fiscal year. Government outlays were $547.8 billion in May and $4.2 trillion through the first eight months of fiscal year 2023. By comparison, receipts in May 2022 were $389.0 billion and $3.4 trillion through the first eight months of the previous fiscal year. Expenditures were $455.2 billion in May 2022 and $3.8 trillion through the comparable period in FY22.
  • Inflation/consumer spending: According to the latest Personal Income and Outlays report, the personal consumption expenditures price index edged up 0.1% in May and 3.8% since May 2022. Prices excluding food and energy advanced 0.3% in May, following increases of 0.4% in April and 0.3% in March. Prices for goods decreased 0.1%, while prices for services increased 0.3%. Food prices increased 0.1% and energy prices decreased 3.9%. Since May 2022, consumer prices for food increased 5.8%, while energy prices declined 13.4%. Personal income rose 0.4% in May, 0.1 percentage point greater than the April increase. Disposable personal income increased 0.4% in May after advancing 0.3% in April. Consumer spending increased 0.1% in May, after rising 0.6% in the previous month.

  • The Consumer Price Index rose 0.1% in May after increasing 0.4% in April. Over the 12 months ended in May, the CPI advanced 4.0%, down from 4.9% for the year ended in April. Excluding food and energy prices, the CPI rose 0.4% in May and 5.3% over the last 12 months. Contributing to the May CPI advance were increases in prices for shelter (0.6%) and used cars and trucks (4.4%). In May, food prices increased 0.2% and 6.7% since May 2022. Energy prices fell 3.6% in May and are down 11.7% over the 12 months ended in May.
  • Prices that producers received for goods and services decreased 0.3% in May, following a 0.2% increase in the previous month. Producer prices increased 1.1% for the 12 months ended in May. The Producer Price Index saw prices for goods fall 1.6%, while prices for services increased 0.2%. Producer prices less foods, energy, and trade services were unchanged in May after increasing 0.1% in the previous month. Prices less foods, energy, and trade services advanced 2.8% for the year ended in May after increasing 3.3% from the 12 months ended in April.
  • Housing: Sales of existing homes increased 0.2% in May. Since May 2022, existing-home sales dropped 12.7%. According to the report from the National Association of Realtors®, job gains, a dearth of inventory, and fluctuating mortgage rates have contributed to the decline in sales of existing homes. The median existing-home price was $396,100 in May, up from $385,900 in April but lower than the May 2022 price of $408,600. In May, unsold inventory of existing homes represented a 3.0-month supply at the current sales pace, up from the April pace of 2.9 months. Sales of existing single-family homes dropped 0.3% in May and 20.0% from May 2022. The median existing single-family home price was $401,100 in May, up from the April price of $390,200 but well below the May 2022 price of $415,400.
  • New single-family home sales advanced in May, climbing 12.2%, marking the third consecutive monthly increase. Sales were up 20.0% from a year earlier. The median sales price of new single-family houses sold in May was $416,300 ($402,400 in April). The May average sales price was $487,300 ($495,600 in April). The inventory of new single-family homes for sale in May decreased to 6.7 months, down from 7.6 months in April.
  • Manufacturing: Industrial production declined 0.2% in May after increasing 0.5% the previous month. Manufacturing increased 0.1% in May, bolstered by 0.3% increase in durables, which was offset by a 0.1% decrease in nondurables. In May, mining fell 0.4%, while utilities dropped 1.8%. The decrease in mining was driven primarily by decreases in coal mining and support activities (in particular, oil and gas well drilling). The output of utilities declined for the second consecutive month, as electric utilities fell in May, while natural gas utilities remained unchanged. Total industrial production in May was 0.2% above its year-earlier level. Major market groups posted mixed results in May. Notable gains were recorded in defense and space equipment and construction supplies. Most other major market groups recorded modest declines.
  • New orders for durable goods increased 1.7% in May after increasing 1.2% in April. New orders for transportation equipment led the overall increase, advancing 3.9% in May, marking the third consecutive monthly advance. Excluding transportation, new orders increased 0.6% in May. Excluding defense, new orders rose 3.0%. Over the past 12 months, new orders for durable goods have increased 3.5%.
  • Imports and exports: May saw both import and export prices decrease. Import prices fell 0.6%, following a 0.3% increase in April. Prices for imports declined 5.9% over the past year, the largest 12-month drop since the index declined 6.3% for the 12 months ended in May 2020. Import fuel prices decreased 6.4% in May, following a 4.1% jump in April. The May decline in import fuel prices was the largest monthly drop since August 2022. Nonfuel import prices edged down 0.1% in May after being unchanged in the previous month. Lower prices in May for nonfuel industrial supplies and materials and foods, feeds, and beverages more than offset higher prices for automotive vehicles and capital goods. Nonfuel import prices declined 1.6% over the past year. Export prices dropped 1.9% in May, the largest monthly decrease since December 2022. Falling prices for both agricultural and nonagricultural exports contributed to the overall decline in export prices in May. Export prices fell 10.1% for the year ended in May, the largest 12-month decline since the series was first published in September 1984.
  • The international trade in goods deficit fell $6.0 billion, or 6.1%, in May over April. Exports of goods for May were $1.0 billion, or 0.6%, below April exports. Imports of goods were $6.9 billion, or 2.7%, less than April imports. The May decrease in exports was mainly attributable to declines in other goods (-13.2%) and foods, feeds, and beverages (-14.2%). The decrease in May imports was largely driven by a 7.3% decline in consumer goods.
  • The latest information on international trade in goods and services, released June 7, was for April and revealed that the goods and services trade deficit was $74.6 billion, an increase of 23.0% from the March deficit. April exports were $249.0 billion, 3.6% less than March exports. April imports were $323.6 billion, 1.5% above March imports. For the 12 months ended in April, the goods and services deficit decreased 23.9%. Exports increased 5.8%, while imports decreased 2.3%.

London, UK parliament building, big ben

  • International markets: China’s post-pandemic economic recovery showed new signs of weakness in June. Manufacturing in China contracted for the third straight month in June, while the services sector also weakened. The latest data likely prompted the Chinese government to lower the one-year loan prime rate by 10 basis points. With inflationary pressures continuing to rise, the Bank of England hiked interest rates by 50 basis points in June, marking the 13th consecutive interest rate increase. Elsewhere, in Germany, manufacturing declined in both goods and services sectors. What was often the fulcrum of the German economy, weak global demand has impacted German exports. For June, the STOXX Europe 600 Index was flat; the United Kingdom’s FTSE slid 0.8%; Japan’s Nikkei 225 Index gained 5.3%; and China’s Shanghai Composite Index dipped 0.9%.
  • Consumer confidence: The Conference Board Consumer Confidence Index® increased in June to 109.7, up from a revised 102.5 in May. The Present Situation Index, based on consumers’ assessment of current business and labor market conditions, rose to 155.3 in June, higher than the May reading of 148.9. The Expectations Index, based on consumers’ short-term outlook for income, business, and labor market conditions, advanced to 79.3 in June from 71.5 in May. According to the Conference Board’s report, the Expectations Index has remained below 80.0, the level associated with a recession within the next year, since February 2022, with the exception of a brief uptick in December 2022. However, June’s reading was just a shade below 80.0 and up sharply from prior month’s rate.

Eye on the Quarter Ahead

During the third quarter, investors will likely focus on inflation data and the Federal Reserve’s response. Concerns over slowing economic activity, both here and globally, also will influence the market going forward.

Data sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Department of Commerce (GDP, corporate profits, retail sales, housing); S&P/Case-Shiller 20-City Composite Index (home prices); Institute for Supply Management (manufacturing/services). Performance:  Based on data reported in WSJ Market Data Center (indexes); U.S. Treasury (Treasury yields); U.S. Energy Information Administration/Bloomberg.com Market Data (oil spot price, WTI, Cushing, OK); www.goldprice.org (spot gold/silver); Oanda/FX Street (currency exchange rates). News items are based on reports from multiple commonly available international news sources (i.e., wire services) and are independently verified when necessary with secondary sources such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied on as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. U.S. Treasury securities are guaranteed by the federal government as to the timely payment of principal and interest. The principal value of Treasury securities and other bonds fluctuates with market conditions. Bonds are subject to inflation, interest-rate, and credit risks. As interest rates rise, bond prices typically fall. A bond sold or redeemed prior to maturity may be subject to loss. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.
The Dow Jones Industrial Average (DJIA) is a price-weighted index composed of 30 widely traded blue-chip U.S. common stocks. The S&P 500 is a market-cap weighted index composed of the common stocks of 500 largest, publicly traded companies in leading industries of the U.S. economy. The NASDAQ Composite Index is a market-value weighted index of all common stocks listed on the NASDAQ stock exchange. The Russell 2000 is a market-cap weighted index composed of 2,000 U.S. small-cap common stocks. The Global Dow is an equally weighted index of 150 widely traded blue-chip common stocks worldwide. The U.S. Dollar Index is a geometrically weighted index of the value of the U.S. dollar relative to six foreign currencies. Market indexes listed are unmanaged and are not available for direct investment.

The Recession We’re Still Waiting For

Key takeaways

The recession everyone was predicting at the start of the year has yet to come to fruition.

What Recession?

Coming into 2023, most economists were pretty convinced that the U.S. economy would dip into a recession—it was a consensus forecast. Using a Philadelphia Fed survey from January, nearly 44% of respondents predicted a recession would happen at some point in the next 12 months, the highest number in more than a decade. Obviously, the year’s not over, and it’s not time to celebrate—but to date, recession fears have not metastasized into the real thing.

Philly Fed Recession Probability Index (next 4 quarters)
Source: Philadelphia Fed – Click to enlarge details

And if we are in a recession, it’s a weird one. One example? Travel demand. More than 2.5 million people traveled through U.S. airports per day in June, the most since July 2019.

Airbus—the second largest aircraft manufacturer—recently provided a business update, mentioning: “We cannot make planes fast enough to satisfy the demand. An airplane order these days is essentially just reserving a spot in the backlog.” Boeing—the largest aircraft manufacturer—echoed the same sentiment, noting that many orders for planes in its backlog won’t be delivered until the 2030s. In the words of Boeing CEO Dave Calhoun: “Why are people ordering airplanes out into the ‘30s now? Because they see the same thing,” referencing long-term demand trends for airline travel.  Strong long-term demand trends are not only unique to airlines; cruises are seeing a similar demand pattern. In a recent earnings call, Carnival Cruise Lines mentioned booking volumes are at all-time highs and the “booking curve is as far out as we’ve ever seen it.”

While the next six months could look a lot different, there has not been a recession yet. And some people are losing confidence one will come—the Philadelphia Fed survey prediction has fallen to 30%.

July Fed Meeting

Target Rate Probabilities
Source: CME FedWatch Tool – Click to enlarge details

The June Fed meeting was significant. After 10 consecutive meetings with rate hikes, the Fed finally decided to pause, holding the federal-funds rate at a range of 5.00%–5.25%. Many referred to the Fed’s decision as a “hawkish pause,” however, as the Fed alluded to more rate hikes in the future. Looking toward the July Fed meeting, the market is currently expecting the Fed to hike rates 25 basis points (bps) again.

But after the July meeting, the market is not forecasting any more rate hikes. In fact, the futures market is expecting a rate cut by May of next year. To be clear, none of this is promised—but it does provide some signal based on the current facts we have. One of the main factors allowing the Fed to get less aggressive with rates—the consistent downward trend in inflation.


The May inflation report was released a day before the Fed’s June meeting, and it showed a decline in the overall inflation rate to 4.1%. This was the 11th consecutive decline in the year-over-year rate and lowest level since March 2021. Inflation was growing at a rate of roughly 9% last May—and while still growing—the rate of growth has dropped considerably. What’s driving the decline?

Consumer Price Index Graph YoY % Change
Source: FRED – Click to enlarge details

Energy components—gasoline and fuel oil—are completely rolling over. Used cars and trucks turned negative after large increases during the pandemic. And even areas of travel—airline fares and lodging—that reflected “revenge spending” are slowing down from extreme rates of growth. One extra consideration: extreme improvement in supply chains. By one measure—the New York Fed Supply Chain Index—the pressure on the U.S. supply chain has moved from its worst level ever (December 2021) to its best level ever (May 2023) over the past 18 months.


U.S. home prices fell 0.2% over the past year, the first year-over-year decline since 2012. One might think the housing market is in trouble based on that data point. However, reality is something much different. All the major U.S. homebuilders have stock prices trading near all-time highs. Considering a 30-year mortgage has gone from approximately 3% to 7% over the past two years, it’s hard to understand how homebuilders could be having success. This is a feature of markets and investing: They often fool the masses.

Number of Homes Built in US be Decade Bar Graph
Source: Statista – Click to enlarge details

Homebuilders have one simple factor driving them: limited inventory. Lennar—a large homebuilder—recently discussed this on an investor call: “Consumers have come to accept a new normal for interest rates and demand has accelerated, leaving the market to reconcile the chronic supply shortage derived from over a decade of production deficits. Simply put, America needs more housing.” In the four decades leading up to the global financial crisis, nearly 26 million new homes were built in each decade. In the most recent decade, only 5.8 million new homes were built.

Needless to say, there’s a lot of catching up to do.

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The Rise of Artificial Intelligence

Executive Summary

We provide a high-level overview of recent developments in artificial intelligence (AI) technology, the implications for industries, and thoughts around investment opportunities.

The launch of OpenAI’s ChatGPT late last year brought AI into the mainstream, capturing people’s imagination and creating a shift in the competitive landscape. Historically, inadequate hardware and software have held back programmers from achieving levels of AI that make it accessible to the masses, but recent improvements to both have allowed developers to break through barriers and generate a step function change in capabilities. The next chapter of AI has begun.

While much of the public discourse is focused on the implications for search, it is our view that AI will have a much broader impact. Hardware manufacturers, software developers and their  corporate clients and end customers will all be affected. Company earnings will be impacted based on adoption benefits to operations and client experiences. In addition, the labor force will need to adapt to more AI in the workplace as both a tool and competition, while policymakers will need to understand how to regulate an influx of nonhuman inputs to labor and knowledge sharing.

How does it work?

Artificial intelligence has been around for decades in various forms, but here we will focus on generative AI and large language models. In short, these forms of AI rely on training and learning from large data sets to interpret user inputs and deliver reliable results.

Generative AI creates output in the form of new content, chat responses, designs, and synthetic data. It operates by using probability models focused on detecting patterns, making decisions, and honing analytics from the data it has been trained on and, for large language models, delivering the most probable next word as it constructs a sentence.

AI products do not yet operate with free will. They require training on data sets from programmers to function. Data are mainly from online sources or data warehouses and can be proprietary or open source.

What are the limitations of large language models?

Programmers must strike a balance between data quantity, quality, and recency — all variables that impact the user experience — but also factor in financial costs. Usually, the more data, the better; however, more data mean greater costs due to, for example, increased computing power needs, potential licensing deals, and more complex model training. Data quality is a priority to prevent a garbage in, garbage out experience for users, and it needs to be logically structured and validated to ensure it is fit for purpose. Keeping these models up to date and relevant is another hurdle because models can operate only according to what they have been trained on. And models can get outdated quickly. It is estimated that 90% of the world’s data was generated in the last two years alone. From 2010 data generated globally has increased by an estimated 60x and is expected to more than double by 20251.

Two other limiting factors are labor supply and the incremental costs of user searches. Also, training an AI model requires both a unique system and a good enough understanding of the data to comprehend the production cycle of the model. On the cost of user searches, for large language models, each word they generate is a new search query which costs significantly more to run than an online search today. And while costs are falling as technology and applications improve, they remain a concern for companies in the near term.

Who stands to benefit?

When it comes to AI, the winners are not yet apparent. Given the pace at which the technology is improving, shiny new objects are bound to grab our attention, but as with many technologies, the first out the gate is not necessarily the long-term winner. For now, our focus is on those holding the picks and shovels, those companies which enable the technology and benefit from increased spending across AI platforms. Active investors can potentially benefit by determining where AI technology can improve margins by generating higher revenues while also lowering operating costs.

Who some of the winners will be is obvious: suppliers of high-end GPUs, cloud computing power, and select software, as AI will require more data. Additionally, hardware providers will be helped by demand for high-end computers, cloud processing centers, and the infrastructure needed for power, cooling, and data storage.

A new ecosystem of software developers, building AI solutions is rapidly emerging. Cloud vendors already monetize AI services and have the hardware, platforms, and capacity (along with the deep pockets required) to build foundational AI models. With much of the technology now available on open-source platforms, the importance of size and scale is an open question. However, many incumbents are well placed to unlock value from AI early on, particularly those with economic moats and scale with respect to data. As our interface with data changes, the opportunity cost of not having consolidated data rises.

Who else could benefit?

Providing they execute, businesses that can offer improved products and services to clients deploying AI should provide an opportunity to widen moats, generate incremental revenue, and improve margins. AI technology can improve creative industries and benefit areas such as health care, factory automation, logistical and industrial processes. In addition, consultants who help businesses understand and implement the technology could benefit as well as those with differentiated data sets.

We don’t believe AI and language models will replace traditional web-based searches. Our view is that AI will be complementary to search since these knowledge models are not fact-based but rather a function of the data they can access combined with the training protocols applied by developers (and thus vulnerable to error). We think it likely that the rising tide of AI will lift all boats and result in other advantages for current players in the ecosystem.

Who gets disrupted?

Traditional AI models capture accumulated knowledge to do the same things employees do, albeit with a better memory and no emotion. At a minimum, they are well suited to driving the  automation of routine tasks, workflow, and reconciliation. Generative AI and language models take this a step further and can be used as a creative force in producing images, video, and text, thus potentially threatening the careers of programmers, writers, graphic designers, and video editors. As a result, software solutions may become redundant. Single product or horizontal solutions appear most at risk, as are those dedicated to organizing, structuring, and analyzing data. Additionally, the integration of AI will alter management’s relationship with those in the labor force while changing the revenue and earnings paths of multiple industries.

What are the concerns over the societal impacts?

There are always bad actors who will try to use technology to take advantage of people, and distinguishing fact from fiction in AI-generated content will be a major concern. Additionally, we could reach a point when AI models are used to train other models. AI output could be incorporated into training data sets, tainting their reliability. And AI systems can be susceptible to bias and errors if they are trained on data that is skewed, incomplete, or outdated, which can lead to inaccurate results and erroneous decisions. Not only does running AI models use a lot of energy, but the manufacture of semiconductor chips used to power AI also requires significant energy, mining efforts, and chemicals. Then there are the broader societal questions and the potential for social upheaval as knowledge workers are disintermediated, potentially endangering the middle class as we adjust to the adoption of AI. Will AI invade our emotional intelligence and make memory and intellect less valuable or even unnecessary? Could it get out of control? Will the potential spoils go to a select few? It is too soon to tell, but it is clear that these are important societal and policy questions which will need to be addressed.


While we remain early in the evolution and adoption cycle of generative AI, improvements and adoption appear poised to accelerate. As for its popularity, it took well known Internet platforms a couple of years to reach the one-million-user mark, popular social media websites only a few months to do that, but ChatGPT only five days to gather the same following — and only two months to reach 100 million users. There is no doubt technology evolving and growing at this pace will cause issues along the way, but with so much at stake, technology companies will be forced to play in this space.

In our view, if AI is the tool to deliver the next technological revolution, then generative AI and language learning models will facilitate this change. Unlike previous technologies, these tools are not simply solutions seeking a problem but a potential solution to many different problems. We believe the impacts will be felt beyond both traditional search and technology companies, and that it will have broader implications for every industry.

Currently, there is a lot of excitement over the potential for AI. However, given the speed with which it is evolving, we need to be comfortable that the expectations match the opportunities and their corresponding risks. We think there will be opportunity in the infrastructure companies supporting the AI revolution, as well as those leading the race to integrate AI into their products and services across industries.

1 Exploding Topics 2023 — “https://explodingtopics.com/blog/data-generated-per-day”
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