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Weekly Market Update

Our Asset Allocation team comments on what’s moving markets and how the PIMCO GIS Dynamic Multi-Asset Fund (DMAF) is positioned.

FOREWORD

  • Access these views via the Dynamic Multi-Asset Fund, a dynamic fund designed to deliver across market environments and help investors navigate the toughest market situations.

From the desk of Our Asset Allocation team, Friday 12th April 2024.

I Got the Power

The Power by German dance group Snap!, released in 1990, could not be more appropriate right now, as corporates race to secure the energy they require to power technology-related activities – in particular its lyrics, “you could break my heart apart”. As we enter a fresh earnings season for Q1, 2024, it is also worth remembering a few numbers: in the first quarter of the year, the S&P500 gained 9.8%, though it took only six stocks out of 500 to generate 60% of the performance and only one stock, Nvidia, to generate a quarter of it.

Artificial Intelligence (AI) is powering an incredible market rally, fueling hopes of a productivity boom and more. Analysts have continuously revised upward their trajectory for the technology’s deployment and the industry sees Nvidia shipments increasing tenfold by 2026 compared to 2023.

''To paraphrase Snap! again, the question is becoming: Who’s got the power?''

AI has an insatiable thirst for power or electricity that gets very few mentions. According to the IEA in a recent report, a ChatGPT search requires about 10 times the amount of power of a typical Google search. Between 2023 and 2026 the energy consumption of the AI industry is forecast to rise by 10 times, while crypto activity will likely see its power consumption go up by around 60%. Globally, tech power consumption (including traditional data centers plus AI activities and crypto) was estimated at 460 TWh (terawatt hours, which equals one trillion watt hours) or 2% of global electricity consumption in 2022. But by 2026, the base case is for around twice that amount and potentially above 1,000TWh.

In a recent WSJ interview, ARM CEO Rene Haas claimed that technology activity could consume as much as 20% of US electricity requirements by the end of the decade, from less than 4% today without greater efficiency of chips. Indeed, the issue is particularly acute in the US, where 33% of global data centers are hosted.

Power could well constrain development of AI, all the more so now that tech giants have net-zero carbon pledges and will need a vast amount of renewable energies to power AI. All of a sudden, electricity companies that had been considered “ex-growth bond proxies” could indeed have “the power”, and see growth levels well in excess of GDP. We have not even touched on the impact of electric vehicles, and electrification needs to ensure decarbonisation of energy.

The lack of power and grid capacity is becoming better understood by tech giants, which are busy securing vast amounts of renewable energy around the world. But perhaps the most intriguing development was the deal struck between Amazon and Talen Energy in early March, where Amazon secured a data center next to a nuclear power plant to receive electricity directly, rather than via the grid. The energy deal could expand data center capacity equivalent to the energy consumption of 900,000 homes. Triangulating data from Talen management’s hypothetical PPA (Power Purchase Agreement) scenario of the deal, as well as the recent management call, it is understood that Amazon will be paying a premium of $25/MWh above the PTC (production tax credit) floor of $45/MWh – or a premium in excess of 50%. But securing power ahead of the competition, given the lead times of electricity capacity installation, could be a big differentiating factor in the AI race.

In this back-up in yields, US utility companies have seen a great de-rating relative to their own history, with a 12-month forward PE ratio about 1 standard deviation below its 10-year average, but also relative to the S&P500 of the order of 25% since early 2022. Ultimately, the chip industry will come up with more efficient chips but it could well be that the constraint to AI deployment will be power and not chips.

Geraldine

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Data as of 12th April 2024 unless otherwise stated.

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OUTLOOK
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