Meta stock plunges as markets reassess impact of AI

Meta’s earnings were always going to be a key event for financial markets, they are the first of the mega cap tech stocks to report results, at the same time as being a large player in AI, which is central to its future business strategy. These earnings were a test to see if big tech firms that implement AI tech, rather than make the hardware, can generate revenue from AI. On this front, Meta’s earnings were a disappointment. In after hours trading, Meta’s share price slumped 16%, as the market reassessed their outlook for a stock that has rallied more than 40% so far this year. 

Overall, Meta’s earnings were strong. Its Q1 revenue was $36.46bn, beating expectations of $36.12bn. EPS was also stronger than expected, at $4.71 vs. Expectations of $4.30. Ad revenue for the first quarter was also a touch above forecast at $35.64bn. Looking at the headline figures, these are a solid set of earnings, that suggest Meta’s business model is just fine. However, scratch below the surface and there were some worrying trends. Firstly, Meta’s Q2 revenue forecast was $36.5bn to $ 39bn. The market had expected $38.24bn, so the lower end of the forecast range may have spooked investors and helped to trigger the sell off. 

More important to the decline in Meta’s share price on the back of this earnings report, is the large 10% increase in expected capex spend. It increased to $35bn - $40bn, up from their previous guidance of $30bn - $37bn. 

When Mark Zuckerberg attempted to justify the increased spend, it merely sent the stock price lower. He said that the length of the AI investment cycle is 2 years, and only after that can Meta think about monetisation of AI. Patience is required before AI pays off, however, the market is not a patient beast. These earnings suggest that there is little evidence that AI is paying off for now. Also, forecasts for greater capex spend, suggest that AI is an expensive tool. 

This did not deter Zuckerberg to wax lyrical about AI on the earnings call. If it was a dinner party then AI would have been the only dish on offer, which seemed to irate the market more. Going into the earnings call, the market wanted some colour on a couple of things, including any positive impact on Meta’s future earnings from the TikTok ban. However, Meta execs were tight lipped on this. Some detail on the sales of Meta’s Ray Ban smart sunglasses may have also placated the market, however, that was also missing from this report. The Ray Bans can be an AI assistant for the user, since they see and hear what we do. However, the lack of detail on sales, except to say that they were flying off the shelves, wasn’t good enough to trigger a recovery in this stock. 

Instead, the market focussed on yet more losses for Reality Labs, the home of the Metaverse, which lost more than $3bn in the last quarter, similar to the level of losses registered a year ago. 

AI is an industry- wide stock market bet, so it is no surprise that the bad reception to Meta’s earnings has had a knock on effect and other Mag 7 stocks are also selling off. At this stage of the reporting season, AI is still a cost centre rather than a profit generator for tech companies, which is worrying the market. They are the big users of AI at this stage, if they are struggling to monetise AI tech, what hope do other industries have? 

Of course, this is a pessimistic outlook, and as Meta assumes, there is a good chance that AI, like any new tech, just needs time to develop before it can be monetized. However, the market is also sensitive to any talk by Meta about an increase in spending, after fears in 2022 that spending on the Metaverse would grow out of control. Wednesday’s earnings call suggests that the era of austerity and cost control at Meta is a relic of the past, and Zuckerberg is happy to turn on the capex taps in order to make AI a central feature of Meta. 

The trouble with Zuckerberg’s vision is that Meta is an advertising company at heart and this is its main revenue generator. However, it is an ad company that is currently dabbling in expensive AI activities that don’t generate enough cash to excite the market.

The stock sell off is steep, but Meta had rallied hard this year. Some are also arguing that Tesla’s share price surge after its Q1 earnings report is unfair, as Meta delivered good results, while Tesla delivered a truly dreadful set of first quarter results. However, stock markets are notoriously forward looking, so the forward guidance is what really matters. Meta’s cautious stance on forward revenue guidance and higher spending plans have spooked the market. The market seems to be punishing stocks that are not evangelical about their future prospects, remember the reaction to JP Morgan’s results? The real test for the market’s tolerance of AI, will come with Thursday’s Microsoft earnings. The market wants to hear promises of AI-related greatness before  this theme returns as a key driver of the stock market. The bar for tech earnings is high. 

Elsewhere, global stocks may struggle on Thursday and they could lack direction, as investors reassess the outlook for the global economy and interest rates. Global sovereign bond yields rose sharply on Wednesday, with German bund yields and UK gilt yields both rising nearly 10 basis points. This is a huge move, and is down to some rebalancing that is going on. As the economic strength and persistence in inflation that we have seen in the US seeps through to other economies, the market is repricing expectations for ECB and BOE rate cuts. Treasury yields were also higher on Wednesday, however the 10 year yield only rose by 4 basis points and Treasuries outperformed Gilts and Bunds. This suggests that the market is expecting to be disappointed by the ECB and BOE’s rate cutting potential, which is bad news for their bonds, but could be good news for the currencies and limit further downside vs. The USD. 

The market is also having to deal with a strong Dollar – USD/JPY is particularly

Volatile and broke above the key 155 level on Wednesday. This is the lowest level of the yen vs. The USD since 1989. History tells us that USD/JPY could rally further from here. While BOJ intervention is a real and present danger, we think that they will wait until their BOJ meeting on Friday. There is some pressure on them to do/ say something to stop the yen’s decline. The Bank of Indonesia raised interest rates this week in part to support their currency. Will the BOJ follow suit? We don’t think so at this stage, but they could signal more rate hikes for this year and a clearer time line and justification for the hikes. If this happens then we could see major volatility in USD/JPY at the end of this week. 

Tensions are once again rising in the Middle East, which could also hurt risk sentiment. Thus, it’s hard to see the rally we have seen this week continue in the short term, and Meta’s earnings could knock sentiment. However, the optimist in me thinks that any weakness In the Mag 7 could help narrow the gap between them and the rest of the market, especially if we get continued strong earnings data.