Big Tech under pressure as Microsoft results put AI costs in spotlight

By Shreyashi Sanyal and Amruta Khandekar

(Reuters) – A number of U.S. big tech companies fell on Wednesday as Microsoft (NASDAQ:)’s results signaled how the high-stakes battle for AI supremacy will cost the tech giants that have seen their shares rally in recent months on hype around the technology.

Microsoft’s shares fell 3.6% in early trading as the company laid out an aggressive AI-related spending plan, saying deeper investments in AI are required before gains trickle to the bottom line.

Microsoft is set to shed about $100 billion from its market capitalization if the loses hold until close of trading. Its shares had gained 46.4% up to yesterday’s close.

“AI will generate a lot of revenue and earnings for such firms, but a lot of investors have been buying the rumor and now that we have earnings, they are taking profits,” Paul Nolte, senior wealth advisor and market strategist for Murphy & Sylvest said.

“There’s still a lot of excitement around AI, but nobody quite understands what that means for the bottom line of many of these companies.”

The NYSE FANG+ index, which houses many megacap growth names, was down 0.2%. The index has risen about 76% so far this year, driven by the frenzy around AI.

Google-parent Alphabet (NASDAQ:) was an outlier. Its shares rose 5.6% after the company beat expectations for second-quarter results. Alphabet looks set to add about $100 billion to its market capitalization.

The recent rally has driven up Microsoft’s valuation. The stock is trading at 31 times 12-month forward earnings, compared to a PE multiple of 20 for Alphabet.

“The tech earnings season has started on a mixed note,” said Mark Haefele, global wealth management chief investment officer at UBS in a client note.

“The tone set by quarterly results over the next week will be crucial to the performance of tech stocks through the rest of the third quarter.”

Apple Inc (NASDAQ:), the world’s most valuable publicly listed company, and Amazon.com Inc (NASDAQ:) are set to report quarterly earnings next week.

FED FEARS vs. AI BOOST

Investors also remained cautious on Wednesday, with Wall Street’s main indexes muted ahead of a likely Federal Reserve interest rate hike later in the day that could push borrowing costs to their highest since the global financial crisis.

Large tech companies, which rely heavily on borrowed money, have been pressured since the Fed started its tightening cycle to tame inflation.

However, optimism over AI and hopes that the Fed is nearing the end of its rate hiking cycle have supported tech stocks in recent months.

Stuart Cole, chief macro economist at Equiti Capital, said tech stocks tend to be fairly exposed to such sentiment around central bank policy as many of them are reliant on robust economic growth to deliver the returns they promise.

“There are valid concerns that the U.S. economy is weakening, but until the Fed sees sustained evidence of softening inflationary pressures, the hawkish stance will be maintained, even at the risk of tipping the economy into negative growth.”

Meta Platforms Inc (NASDAQ:)’s shares rose 1.0% after Alibaba (NYSE:)’s cloud computing division said it has become the first Chinese enterprise to support the company’s open-source artificial intelligence (AI) model Llama.

Amazon shares dropped 1.3% after a media report said the Federal Trade Commission is finalizing an antitrust lawsuit against Amazon.

Snap Inc (NYSE:) shares tumbled 18.3% after the photo messaging app-owner reported a weaker third-quarter forecast than analysts had expected on Tuesday.

“Band-Aids not fixing bullet holes yet,” wrote Bernstein stock analyst, Mark Shmulik.

The company’s Snapchat app has added a new AI-powered chatbot that can answer questions to attract more users, but Shmulik notes the company has struggled to consistently grow revenue and catch up to rivals like Facebook-owner Meta.

“Snapchat is running to stay in the same place while peers enviously get back on the ad growth track,” Shmulik said.