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Around the Hill Volume 9 - How Big Will the Generative AI Market Be?

Generative artificial intelligence is still everywhere. It was a sleepy week in the markets as investors awaited a resolution to the debt ceiling impasse in Washington D.C. though leaders appeared closer to a deal than the prior week. There were a lot of speeches from Federal Reserve officials that showed a reluctance to cut rates anytime soon but did point to some debate if further rate hikes are required. Chinese key economic data, including retail sales and industrial production, was softer than expected. 

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Generative AI is Everything, Everywhere, All at Once: But How Big Will it Be?

Generative artificial intelligence (generative AI or GAI) is the talk of the town and dominating corporate board rooms, earnings conference calls and investor attention. Where are we in the development cycle of GAI tools and technologies and how big can it be?

Interest in artificial intelligence in corporate presentations such as earnings conference calls is booming and eclipsing that of much larger markets such as cloud computing. The rise of generative AI and applications such as chatGPT and AI search are driving new interest, especially as executives see an opportunity to further optimize their operations by driving more efficiencies with these new tools.

Source: Bloomberg, May 16, 2023

What companies are dominating the conversation around AI so far in 2023? It makes sense that technology and communications services (which includes Internet titans like Google-parent Alphabet and Meta Platforms) companies are discussing AI the most. But AI is everywhere as the following two charts demonstrate:

Source: Bloomberg, May 16, 2023

We believe that generative AI has the potential to disrupt nearly every corner of the global economy by providing a kickstart to worker productivity and enabling companies to do more with the resources they already have, possibly do more with fewer workers or do things that previously were not feasible from an economic perspective. Goldman Sachs estimates that the total economic value gain from the GAI productivity boost could reach $7 trillion over time while the Brookings Institute sees the possibility for an even larger boost to the global economy.

Moving away from the broad macro impact and looking at specific sectors, our analysis shows that generative AI enterprise software could become a $121 billion market over the next decade. Although there’s lots of uncertainty around the path of technology development and adoption, we believe our framework provides a good way to think about the take-up of GAI software over time.

Source: World Bank, International Monetary Fund, IDC, Bloomberg, Roundhill Investments, April 28, 2023

Our model uses several key inputs to estimate future GAI enterprise software revenue. First, we take the World Bank’s estimate of the global labor force, which was 3.5 billion people as of 2021. We grow the labor force at the IMF’s long-term growth rate estimate of 1.1% per year to reach a 2033 labor force estimate of nearly 4 billion people. For software expenditures, we grow IDC’s estimate for 2021 total software spending at IDC’s long-term software spending CAGR of 10.5% to reach a 2033 software market size. We then calculate the monthly software expenditure per employee from these inputs.

In addition to the enterprise, we can already see some areas where generative AI can impact everyday consumers. While it is far too early to identify all relevant use cases, one market that we believe to be exposed is online search. Market leader Google and challengers such as Microsoft’s Bing are rapidly rolling out GAI-powered search to provide a more sophisticated and responsive search experience. 

The search advertising market generated $231 billion of revenue in 2021 and is forecast to grow at a 9.9% annual growth rate through 2027 to over $400 billion, according to Magna Global. If this growth rate continues longer-term, it suggests a 2033 market size of $655 billion of search advertising revenue. If 50% of search is GAI-powered in 2033, that would mean that GAI search alone is generating over $325 billion of annual advertising revenue.

It’s obviously early days for generative AI and the hype cycle is alive and well but we believe that this can be one of the most transformative technologies of the next decade and potentially unleash a multi-trillion dollar wave of economic productivity growth.

This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product. It is provided for information purposes only and on the understanding that the recipient has sufficient knowledge and experience to be able to understand and make their own evaluation of the proposals and services described herein, any risks associated therewith and any related legal, tax, accounting or other material considerations. To the extent that the reader has any questions regarding the applicability of any specific issue discussed above to their specific portfolio or situation, prospective investors are encouraged to contact Roundhill Investments or consult with the professional advisor of their choosing.
Investing involves risk, including possible loss of principal. Artificial Intelligence (AI) Companies and other companies that rely heavily on technology are particularly vulnerable to research and development costs, substantial capital requirements, product and services obsolescence, government regulation, and domestic and international competition, including competition from foreign competitors with lower production costs. Stocks of such companies, especially smaller, less-seasoned companies, may be more volatile than the overall market. AI Companies may face dramatic and unpredictable changes in growth rates. AI Companies may be targets of hacking and theft of proprietary or consumer information or disruptions in service, which could have a material adverse effect on their businesses.

Notable & Quotable

The debt ceiling isn’t yet resolved but Congressional leaders appear to be inching closer to a deal, lifting investor sentiment last week. With the Treasury’s “X date” approaching on June 1 for when the U.S. would breach the debt ceiling, the pressure is on. President Biden met with Congressional leaders last week and now the Republican leadership is negotiating directly with the White House, which is raising expectations that they can reach a deal.

China’s key economic data this week was softer than expected, raising concern that the re-opening of its economy post-pandemic restrictions is not going as smoothly and quickly as previously expected. For April, industrial production, retail sales and fixed asset investment growth all came in weaker than expected. It’s to be seen if these numbers are just lumpy and one-off variations or if there has been a shift change in the outlook for the Chinese economy, as monthly data can be volatile.

In the banking sector, Western Alliance Bancorp’s shares rallied 10.2% on May 17 after the company said that it had gained an additional $200 million of deposits since May 9. This brings its total quarter-to-date deposit inflows to $2 billion vs. its total deposits of $47.6 billion at the end of Q1. Although the improving deposits signal that the crisis is easing, we don’t think we’re fully out of the woods and need to be attuned to potential risks in the banking system, especially if economic growth starts to teeter. 

And AI is booming if you weren’t already aware: (C3) shares soared 23% on May 15 (Bloomberg. May 19, 2023) after the company reported preliminary fiscal Q4 2023 revenue that was modestly ahead of estimates while it turned cash flow positive in the period, faster than analysts had expected. The company noted that the business environment for enterprise AI is “more active than we have seen since the company’s inception and seems to be accelerating.” The company signed 43 deals in the quarter, including three for its generative AI products, vs. just five new deals in the year-ago quarter.

Sports betting is also booming: total wagers on sports betting in the U.S. notched a record $31.1 billion in Q1 2023, according to the American Gaming Association, as gross gaming revenue reached $2.8 billion. Handle increased 15.1% year-over-year, fueled by new state launches like Ohio and Massachusetts but also with established markets seeing expansion. The AGA noted that, of the 26 markets that were in operation in Q1 of 2022, 15 of them posted year-over-year growth in total handle. There’s visibility for four more states to launch services over the next few months, according to DraftKings. That would increase the population covered by online sports betting to roughly 53% from roughly 47% currently.

And lastly, circling back to a constant theme of IT spending, Cisco said that new product orders fell 23% in the quarter-ending April and have now declined for four straight quarters. Cisco’s backlog remains large and customer cancellations remain low, which points to customers digesting the deluge of orders they placed over the last few years when the supply chain was tight and delivery times were stretched out. Even though this makes sense, the drop in orders does parallel the broader softness we’ve seen across tech hardware amid the macro uncertainty.

What the Markets Said?

Stocks rose last week, with the S&P 500 Index, Dow Jones Industrial Average and the Nasdaq Composite Index advancing. 

Source: Bloomberg, May 19, 2023

Past performance is not indicative of future performance. The Index returns above are presented for illustrative purposes only. The index returns presented herein do not represent the results of actual trading in investable assets and securities. Index returns do not consider other expenses you may incur when investing or trading an investment strategy, which include, but are not limited to, advisory/management fees, custodian fees and trading fees/commissions. You cannot invest directly in an index. 

Among the S&P 500 sectors, information technology, communications and consumer discretionary outperformed while utilities, real estate and consumer staples lagged.

Source: Bloomberg, May 19, 2023

Looking at select bond and credit market indicators, U.S. government bond yields rose last week. Investment grade and high yield credit default swap spreads narrowed last week.

Source: Bloomberg, May 19, 2023
Note: Bond yield returns quoted in basis points; 2-year/10-year bond yield spread value and return quoted in basis points (1 basis point = 0.01%)

In the commodities space, oil and natural gas futures rose. The VIX Index slipped as the ICE BofA MOVE Index, a similar measure of bond market volatility, rose.

Source: Bloomberg, May 19, 2023

What Economic Data Said Last Week?

Source: Bloomberg, May 19, 2023

What Earnings Said Last Week?

Source: Bloomberg, May 19, 2023

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