AI Bottlenecks and Inflation Risk (with Jonathan Ferro, Lisa Abramowicz, Annmarie Hordern)

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Stocks pushing higher following a boost from Micron's blowout earnings report. Sebastian Page of T. Rowe Price writes AI is an expanding theme from GPUs to other bottlenecks along the data center supply chain.

Jonathan Ferro

Sebastian Page

We have an expanding trade from bottlenecks to more bottlenecks - cooling, electrification, aerospace, gas turbines. AI buildout is $3 trillion by 2028. Key question is when this shows in AI users' margins. We're starting to see companies increasing margins from AI usage anecdotally. We're long US large cap growth stocks.

I use AI to read notes from 300 analysts and ask where companies are increasing margins from AI. I've seen exaggerated estimates but anecdotally we're starting to see it.

The cost to build capacity is increasing evidenced by margins at some companies, while end-user demand is getting fragile with pricing and they're rationing AI spending. How does that make sense?

Jonathan Ferro

Sebastian Page

As long as products keep improving, there is tremendous demand. We're still scratching the surface. PE on Russell 1000 growth is at 22 vs 30 peak over last 5 years - adjustment has been made. You can also play AI bottlenecks in small and midcap. We have a barbell between US large cap growth and small/midcap.

Free cash flows are coming down fast for hyperscalers but the market has adjusted pricing. Once a component becomes a bottleneck in electrification/power supply/data center, that company's stock goes vertical.

People are chasing who has pricing power but Google shares down 8% this month, Microsoft poised for worst monthly loss since 2008 of 19%. The payers of this bill are getting penalized. Is that a warning sign?

Lisa Abramowicz

Sebastian Page

It is absolutely a warning sign - you have winners and losers. This is why skilled active management works. Software companies will be disrupted but the next leg is along bottlenecks to users creating real efficiency. PE of 22 vs 30 range is pretty good for Russell 1000 growth.

I see it in our company - we're creating efficiency and improving processes. A lot of the increase in leverage and decrease in free cash flow margins has been adjusted in the price.

Could you justify further AI investment if borrowing costs were higher in the face of inflation acceleration?

Annmarie Hordern

Sebastian Page

The $3 trillion in spending is generated by companies with tons of cash. We're nowhere near .com bubble levels of corporate leverage. There is demand for the end product - billions of users just scratching the surface. The trend is our friend.

I'm doing roundtables with investors and many peers are just starting to use AI agents. As long as demand for the end product is there, people will pay. We'll go through ups and downs but $3 trillion spending by 2028.

You're concerned that even with lower oil prices there's still a lot of inflation baked in. Is the Fed potentially having to hike going to be an issue?

Annmarie Hordern

Sebastian Page

25-50bp of hikes wouldn't be a big issue for markets. Inflation right now is underestimated as a risk. There's pent-up inflation with lots of lags working through - from fertilizer to food, freight to final goods. Last 3 months headline CPI annualized is 8%. Shelter last 3 months is 4.8%. The market is underpricing inflation risk.

The 1-year breakeven is 1.7% and 1-year inflation swap is 2.2%. I'm not forecasting today's print but as a general trend, inflation is underestimated by the market based on breakevens and inflation swaps.

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