Morgan Stanley urges 'barbell' AI strategy with adopters

Morgan Stanley's note provides investors with a reason to rotate rather than sell: funds exiting crowded AI hardware positions will flow into software and non-tech adopters rather than leaving the AI theme. This could help U.S. equity gains broaden beyond megacaps. The weakest part of the argument is the scarcity thesis for hardware, which depends on bottlenecks such as energy shortages and political factors that could shift quickly. Regulation risk now joins those bottlenecks. A near-term test is Tuesday's White House meeting with tech CEOs on AI. Adopters and infrastructure software appear less exposed to any rules on frontier models than the model builders whose spending drives chip demand.

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Morgan Stanley recommends holding onto AI hardware winners but not depending solely on them. Scarcity should maintain chip profitability for an extended period, while the next round of gains will come from firms that are actually deploying AI.

Here's a summary:

• Morgan Stanley advocates a 'barbell' AI approach: retaining core enablers while adding AI adopters across various sectors.
• Analysts expect demand for computing power to exceed supply for years, with the expansion hampered by energy shortages, local opposition, and political factors.
• Nvidia and Broadcom are favored chip stocks, but investors should be selective with hardware.
• Preferred software names include Microsoft, Snowflake, Datadog, Cloudflare, and Dynatrace.
• Highlighted adopters include iRhythm and Airbnb, which have quantified their AI gains, along with Home Depot, Procter and Gamble, GE Aerospace, and Coca-Cola.
• Sectors identified for AI newcomers include healthcare, real estate, autos, transportation, and consumer services.

Morgan Stanley is pushing investors to adopt a 'barbell' strategy for AI, according to MarketWatch. This involves keeping chipmakers and infrastructure names at the center of the build-out while also moving into a wider set of companies that are beginning to realize real gains from the technology. The advice came in a Thursday note from a team led by analyst Stephen Byrd.

On one side of the barbell are the AI enablers. Chip and infrastructure shares have generally beaten the S&P 500 since the AI wave started. The analysts see potential for additional gains, but they advise selectivity to make room for new ideas. Semiconductor analyst Joe Moore stated that demand from data-center customers is still exceptionally high. He listed Nvidia and Broadcom among his favored picks, driven by spending from AI model developers.

The team forecasts that demand for computing power will exceed supply for years. In previous tech cycles, market leadership usually rotated among sectors as a trend developed. This time, analysts argue that the build-out is being slowed by local opposition, energy shortages, and political issues. This should keep hardware in short supply and provide its suppliers with a longer period of profitability.

On the other side of the barbell are early software enablers and AI adopters, and the analysts say it's time to begin adding exposure to these. In software, analyst Adam Wood prefers infrastructure names such as Microsoft, Snowflake, Datadog, Cloudflare, and Dynatrace. These firms supply the underlying systems that support AI applications.

Beyond technology, the note identifies new AI participants in healthcare, real estate, autos, and consumer services. Analysts contend that the fast scaling of large language model capabilities indicates a wide opportunity for value creation. They emphasize companies that are quantifying the benefits:

• Healthcare company iRhythm Holdings states that AI will reduce the time clinicians spend reviewing medical records by nearly half.
• Airbnb reports that its AI assistant now handles 40% of issues without human intervention and has significantly cut booking times.

The bank also maintains positive ratings on several adopters in more conventional industries, such as Home Depot, Procter and Gamble, GE Aerospace, and Coca-Cola. Transportation and real estate are also noted as sectors to monitor.

The recommendation arrives as investors consider how much longer the concentrated rally in AI hardware can last. By arguing that both enablers and adopters can perform well, Morgan Stanley provides a way to remain in the AI theme while diversifying bets across the market.