Digital Infrastructure Stocks Are Up 7% This Year, Will Generative AI Tailwinds Continue To Drive Them Higher?

Our theme of Internet Infrastructure Stocks – which includes a diverse set of companies that sell hardware and software that underpin the Internet including server processors, graphics units, memory, and networking equipment – has fared relatively well this year, rising by 7% year-to-date, marginally ahead of the Nasdaq 100. This follows a solid 2023, which saw the theme rise by 66% over the year. So what are some of the current developments for the theme?

While the data center players made substantial infrastructure investments during the COVID-19 pandemic, with enterprises taking a pause and hyper scalers working through the inventory leading to a mixed performance for core server and storage players, the infrastructure theme at large in benefiting from the excitement surrounding generative artificial intelligence following the success of OpenAI’s ChatGPT bot.  These AI workloads are computationally intensive and are driving demand for accelerated computing chips and GPUs sold by the likes of Nvidia (NASDAQ:NVDA) and AMD (NASDAQ:AMD). For Q4 2023, Nvidia’s revenue jumped 265% versus last year. The company reports earnings this week. Memory manufacturers such as Micron (NASDAQ:MU) are also expected to see demand rise for faster, higher-density chips, focusing on scaling up DDR5 and high-bandwidth memory (HBM) products. The memory market could also benefit from improving DRAM prices, as major memory manufacturers have been scaling back on production. Things have been a bit more mixed for networking players such as Cisco. While sales picked up over 2023, due to easing supply constraints, the company recently slashed guidance citing weaker demand for networking equipment from telecommunications and cable service providers.

Now AMD stock has seen extremely strong gains of 85% from levels of $90 in early January 2021 to around $165 now, vs. an increase of about 35% for the S&P 500 over this roughly 3-year period. However, the increase in AMD stock has been far from consistent. Returns for the stock were 57% in 2021, -55% in 2022, and 128% in 2023. In comparison, returns for the S&P 500 have been 27% in 2021, -19% in 2022, and 24% in 2023 – indicating that AMD underperformed the S&P in 2022. In fact, consistently beating the S&P 500 – in good times and bad – has been difficult over recent years for individual stocks; for heavyweights in the Information Technology sector including MSFT, AAPL, and NVDA, and even for the megacap stars GOOG, TSLA, and AMZN. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, has outperformed the S&P 500 each year over the same period. Why is that? As a group, HQ Portfolio stocks provided better returns with less risk versus the benchmark index; less of a roller-coaster ride as evident in HQ Portfolio performance metrics. Given the current uncertain macroeconomic environment with high oil prices and elevated interest rates, could AMD and the broader Internet infrastructure theme underperform the S&P 500 over the next 12 months – or will it see a strong jump?

While the structural shift toward greater digitization will drive the theme in the long run, valuations are also a bit high, making the risk-to-reward tradeoff a bit less attractive for the near term. Within our theme, Nvidia stock has been the strongest performer of late, rising by over 220% over the past 12 months, as demand for graphics processing units surged, driven by demand from the AI space.  On the other side, Cisco (NASDAQ:CSCO) stock has fared worse than the other stocks in our theme, declining by about 3% over the last 12 months.

[1] Returns as of 2/21/2024
[2] Cumulative total returns since the end of 2016

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