This piece was originally posted on Davis ETFs website
Summary
- AI likely represents one of the most consequential technological shifts in human history.
- Technological revolutions rarely unfold in a straight line. Instead, they are overestimated in the short run and underestimated in the long run.
- AI will create dramatic divergence between businesses that can adapt and businesses that get left behind.
- Companies will fall into five categories: Emerging Winners, Enablers, Users, Insulated Businesses, and the Walking Dead.
- During this period of massive economic and technological disruption, investors should be wary of passive and momentum-based strategies—which may be disadvantaged during this time of transition.
- Flexible investors applying bottom-up fundamental research, careful stock selection and a rigorous valuation discipline that incorporates the implications of AI will be best-positioned to navigate change in this era.
Introduction
While past periods of technological acceleration, including the print and maritime era (1500–1750), the scientific revolution (1550–1800), the first and second industrial revolutions (1760–1840 and 1870–1914), the atomic and electronic age (1945–1970), and the digital and internet era (1980–2020) provide useful context, the advent of artificial intelligence (AI)1 represents a unique moment in human history that will profoundly transform the political, social, economic and investment landscape.
The rate of this transformation will be neither as fast as the promoters promise nor as slow as the deniers would wish. Instead, like all other revolutionary technologies, it will follow the wave of Amara’s law which states that, “We tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run.”
While we are still in the overestimating/hype phase of Amara’s cycle, our research indicates that the deployment of AI is already accelerating the growth of select, well-positioned and nimble companies by both increasing their competitive advantages and reducing their costs. At the same time, we see an increasing number of once bullet-proof businesses whose competitive advantages and growth prospects are being gradually but relentlessly undermined.
With this investment backdrop, the wheels are beginning to come off many widely accepted but inflexible portfolio strategies, most notably those that are passive, overly diversified, illiquid or reliant on past patterns (such as dividend history), and those that forsake price discipline. In significant transitions, strategies optimized to the past rarely succeed.
Instead, we see the AI transformation rewarding active, adaptable portfolio managers that use fundamental research, careful stock selection and a valuation discipline, and consequently believe investors may be wise to allocate a larger portion of their portfolios away from richly valued indexes and illiquid strategies towards thoughtful, active management.
- For the sake of brevity, we will use the term artificial intelligence (AI) to represent the combined capabilities of what might be called the Intelligence Era. These include large language models, machine learning, agentic AI, and the prospect of so-called artificial general intelligence (AGI).
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