Goldman Sachs' Jim Covello: Why AI's Profit Problem Is Getting Worse

The next phase: Why hyperscalers look more attractive than chips

If the early, easy money in semiconductors has been fully captured, where does Covello see opportunity? His firm is now recommending a relative-value trade: pivot away from semiconductor stocks and toward the three massive hyperscale cloud providers—Amazon, Microsoft, and Alphabet (Google) .

The logic is straightforward. The Philadelphia Semiconductor Index has soared roughly 150% in the past year, with chipmakers already pricing in a perfect future that their customers are struggling to achieve . In contrast, market skepticism about the return on AI investment has compressed the valuations of hyperscale cloud companies, creating what Goldman sees as a potential entry point .

Covello's investment thesis for hyperscalers is uniquely resilient because it identifies two separate paths to a win for investors :

1. The bull case: If AI eventually delivers on its promise, hyperscalers will demonstrate a positive return on investment. This would resolve investor anxiety and lead to a re-rating of their higher stock valuations.
2. The pragmatic case: If AI fails to produce adequate returns, the hyperscalers will be forced to cut their enormous capital spending. This immediate reduction in expenditure would dramatically boost their free cash flow, which would also benefit shareholders.

The primary risk to this trade is a third, more painful scenario: that the hyperscalers continue to spend heavily without ever demonstrating a clear return, simply bleeding cash in a never-ending arms race .

Beyond chips and clouds: The infrastructure ripple effect

While the core equity story is about a rotation from chips to clouds, Goldman Sachs' broader research indicates that the AI capex super-cycle is reshaping investment opportunities in traditional infrastructure as well. The sheer scale of AI's power and connectivity needs is forcing a rapid scaling of underlying industries, creating opportunities in energy, electrical transmission, and data center infrastructure . This part of the thesis is less controversial, as the need for more physical infrastructure to power and house AI is a direct, calculable consequence of the ongoing buildout.

Jim Covello’s overarching message is that investors need to look beyond the hype and follow the financial gravity. For years, all that gravity has pulled profits toward silicon. His bet now is that the next phase of the cycle will begin to pull value back toward the software platforms that must ultimately make the technology pay.