Is Generative AI a Silver Lining for Cloud Stocks?

Cloud stocks have been particularly sensitive to inflation and rising interest rates, with enterprise customers pulling back on their information technology (IT) spending. However, generative artificial intelligence (AI) should be a key driver going forward.

• Cloud servers are likely to be required to handle the increase in large language model training.
• Despite the palpable interest in generative AI, global IT spending is yet to be impacted by the technology.
• How to invest in the cloud: the ProShares Ultra Nasdaq Cloud Computing ETF has rocketed 45% in the past six months.

According to a survey of 200 CEOs conducted in May by IBM [IBM], 64% say that they experience pressure from investors, creditors and lenders to speed their uptake of generative AI.

The respondents also outline two broad fields where generative AI will have a transformative impact: research, innovation and product development; and marketing and sales. The advent of generative AI thus promises to revolutionise business in several ways. However, the rising number of generative AI applications and products seems likely to lead to a rise in the number of large language models (LLMs) that need training. The majority of data to be gathered and analysed may well have to be handled in the cloud.

While running LLMs on cloud-based servers may seem expensive compared with running them on local-based servers, the cloud can actually be more cost-effective, especially for enterprises that don’t have the hardware to run them locally. The cloud also offers improved speed, reduced latency and greater scalability, which is essential if enterprises want to be training multiple LLMs at any one time.

Another benefit is that cloud vendors handle the maintenance and security of servers — cloud servers often boast multiple layers of security and so are far more secure than local servers.

The expected rise in demand for running LLMs in the cloud has sparked a race between the tech behemoths Amazon [AMZN], Alphabet’s [GOOGL] Google and Microsoft [MSFT].

Big Tech Ramps Up Generative AI Support

Back in June, Amazon Web Services (AWS) announced a $100m investment in a generative AI innovation centre that will allow customers to take advantage of “flexible and cost-effective generative AI services for the enterprise”.

Meanwhile, Google has revealed that at least half of venture-backed generative AI start-ups are using Google Cloud, while the figure is 70% for those start-ups valued at over $1bn.

While the company trails AWS and Microsoft’s Azure in the overall market, it’s the preferred destination for younger companies, James Lee, General Manager for start-ups and AI at Google Cloud, told Bloomberg at the end of August.

Microsoft announced last month that it has bolstered an existing partnership with Oracle [ORCL] that will enable the tech giant’s clients to access Oracle’s database services; its cloud infrastructure will be deployed to Microsoft Azure data centres.

“We have a real opportunity to help organisations bring their mission-critical applications to the cloud so they can transform every part of their business with this next generation of AI,” said Microsoft CEO Satya Nadella in a press release. “Our expanded partnership with Oracle will make Microsoft Azure the only other cloud provider to run Oracle’s database services.”

Productivity Benefits Will Differ from Industry to Industry

Generative AI won’t be a one-size-fits-all solution; it will impact productivity in different industries in different ways. For example, semiconductor manufacturers are most likely to benefit from the technology when it comes to research and development, while it’s most likely to drive marketing and customer operations in the banking industry, according to a June report by McKinsey.

At the end of August, MSCI [MSCI] announced it had expanded a partnership with Google Cloud to “accelerate generative AI solutions for the investment industry”. One advantage to MSCI’s clients will be the ability to use conversational AI to receive quick answers and suggestions regarding their portfolio.

“The AI revolution has led to rising expectations among companies and investors, who want faster access to higher quality data, analytics and actionable insights,” Henry Fernandez, MSCI Chairman and CEO, said in a press release.

Generative AI Yet to Impact IT Spending

The hype around generative AI may be palpable, but overall global IT spending is yet to be impacted by it, research by Gartner has found.

“While generative AI is top of mind for many business and IT leaders, it is not yet significantly impacting IT spending levels,” according to John-David Lovelock, Chief Forecaster at Gartner, in a July press release.

Generative AI’s best route to market is through software and hardware that businesses are already using, so the technology is more likely to be incorporated in existing IT spend, he argued.

Lovelock added: “When it comes to AI this year, organisations can thrive without having AI in production but they cannot be without a story and a strategy.”

Cloud to Rise in Tandem with Generative AI

As generative AI deployments and developments continue to accelerate, they should continue to lift the cloud industry as well. Indeed, “it is difficult to view the two as completely separate”, according to Christopher Gannatti, Global Head of Research at WisdomTree.

“We support the view … that AI represents an accelerant to the growth of software, as it gives users yet another reason to look at their tech ecosystem and evaluate whether it is up to their evolving needs,” wrote Gannatti in research published in August.

While the generative AI “battle” will most likely be fought between Alphabet and Microsoft, Amazon is “no slouch”, argued Gannatti.

How to Invest in Cloud Computing

ETFs, or exchange-traded funds, offer an economical and diversified way to invest in a variety of stocks within a particular theme.

Funds in Focus: WisdomTree Cloud Computing Fund

The WisdomTree Cloud Computing Fund [WCLD] has allocated 86.3% of its portfolio to IT as of 19 September. Financials and industrials account for 5.5% and 2.8% respectively, while healthcare and communication services have weightings of 2.8% and 2.7%. The fund is up 7.3% in the past year and up 9.3% in the past six months.

The First Trust Cloud Computing ETF [SKYY] has allocated 50.1% of its portfolio to software and 20.8% to IT services. Technology hardware has a 10.1% weighting, while interactive media and services accounts for 4.6%. The fund is up 20.2% in the past year and up 23.7% in the past six months.

The Proshares Ultra Nasdaq Cloud Computing [SKYU] has allocated IT 86.7% of its portfolio. Communication services, consumer discretionary, industrials, healthcare and financials all have single-digit weightings. The fund is up 22.8% in the past year and up 45% in the past six months.