Are Digital Infrastructure Stocks Like Micron and AMD Still A Smart Bet?

Our theme of Internet Infrastructure Stocks which includes companies that sell hardware and software for server processors, graphics units, memory, and networking equipment, has returned about 16% year-to-date. This compares to the S&P 500 which remains up by about 15% over the same period. The theme had a solid run, driven by excitement surrounding generative artificial intelligence technologies, with accelerated computing chip vendors  Nvidia (NASDAQ:NVDA) and AMD (NASDAQ:AMD) and other players within the computing ecosystem, including memory manufacturers such as Micron (NASDAQ:MU) seeing meaningful gains. However, the theme has seen a pullback in recent weeks amid a broader market sell-off.

There have also been growing concerns about the economy with mixed consumer spending trends and payroll numbers for August coming in below estimates. Concerns of a recession have resulted in considerable market volatility. The current wave of AI deployment is driven in part by the fear of missing out on the next big thing and the use cases for AI aren’t clear yet. Moreover, the costs related to AI are sizable, given the high costs of training and running large models. Most customers have yet to figure out if they can earn meaningful returns on the sizable amounts they are spending on AI data centers.

The increase in the Internet Infrastructure theme over the last 3-year period has been far from consistent, with annual returns being considerably more volatile than the S&P 500. Returns for the theme were 45% in 2021, -38% in 2022, and 68% in 2023. In contrast, the Trefis High Quality (HQ) Portfolio, with a collection of 30 stocks, is considerably less volatile. And it 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 around rate cuts and multiple wars, could the theme face a similar situation as it did in 2022 and underperform the S&P over the next 12 months – or will it see a 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 trade-off a bit less attractive for the near term. Within our theme, Nvidia stock has been the strongest performer of late, rising by more than 120% 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 14% over the last 12 months.

[1] Returns as of 9/9/2024
[2] Cumulative total returns since the end of 2016

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