Microsoft and Meta Trigger an 'Internal Rotation' in the AI Sector
The AI bubble isn’t bursting, but it is rotating and deflating, and selective winners are separating themselves from the pack.
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The indexes are indicated slightly higher on Thursday morning following a benign Federal Reserve decision and mixed earnings results in the AI sector. Reports from Meta (META) , Tesla (TSLA) , and IBM (IBM) are seeing positive reactions, while Microsoft (MSFT) and ServiceNow (NOW) are dropping.
The story of the first major AI reports of the fourth quarter is that not all AI investment is equal. Meta is seeing exceptional AI growth given its primary focus on advertising, while Microsoft is struggling to achieve profitability as it focuses primarily on business software.
The Advertising Advantage vs. the Software Struggle
The clear takeaway from the numbers is that advertising is currently a more profitable AI niche than software. Meta delivered a very impressive quarter with revenue of $59.9 billion, a 24% increase. More importantly, it saw ad impressions rise 18% and the average price per ad increase by 6%. This shows that their AI investments are already paying off, with improved targeting and higher engagement.
Microsoft also reported strong numbers with revenue of $76.4 billion and 39% growth in Azure, but the market is reacting differently. While Microsoft is beating estimates, its gross margins are being squeezed by the massive cost of scaling its AI infrastructure. The company is essentially building the "shovels" for the AI era, but it is taking longer for those software tools and cloud services to generate the same kind of immediate, high-margin returns that Meta gets from its ad engine.
Analyst Reaction and Target Changes
The divergence in performance is already triggering significant price target adjustments Thursday morning. Analysts are effectively rewarding the "ad-driven AI" model while taking a more cautious stance on the "software and cloud" heavyweights.
- Meta: Jefferies is calling Meta’s strategy a "full throttle" push into AI, with many analysts raising targets or maintaining ultra-bullish stances as the ad machine funds the capex arms race. With a current market cap approaching $1.6 trillion, Wall Street eyes a path to the $2 trillion club, with some consensus targets implying 30% upside from here.
- Microsoft: Despite the revenue beat, several firms have trimmed their targets this morning to reflect the margin pressure. We are seeing some targets move from the mid-$600s down toward the $600 or $610 level. While the "Strong Buy" ratings largely remain, the lowered ceiling indicates the market is recalibrating for a longer monetization cycle in the software space.
Massive Spending and Selective Winners
Both companies are doubling down on spending, but the market is rewarding Meta’s clarity. Meta projected a staggering 2026 capex budget of $115 billion-$135 billion, nearly double its previous spend. Investors are cheering because the core ad business is humming along so well that it can easily fund this "superintelligence" race.
As a result, there is an internal rotation in the AI sector. Companies heavily tied to advertising, such as Alphabet (GOOGL) and Meta, are benefiting. Meanwhile, those tied to software and the cloud such as ServiceNow, Snowflake (SNOW) , Salesforce (CRM) , and Datadog (DDOG) are struggling to prove their AI tools are moving the needle fast enough. Meanwhile, infrastructure plays such as Nvidia (NVDA) , and data centers are mixed as investors weigh the massive spending plans against the long road to software profitability.
Finding Focus in a Deflating Bubble
The AI bubble isn’t bursting as the bears have been warning about for years, but it is rotating and deflating, and the primary winners are separating themselves from the pack. This means investors will need to focus more on individual stocks and more precise themes than on buying AI as a generic mega-trend.
The mixed message in the AI sector will keep the indexes volatile, but some new rotational action under the surface is likely to gain traction. The small-cap group has suffered an ugly reverse rotation over the last four sessions, with biotechnology being particularly poor. The jump in the Magnificent Seven group continues to be driven by Tesla, Alphabet and Meta, but it is weighed down by Microsoft and Amazon (AMZN) .
Apple and the Final AI Test
Apple (AAPL) reports Thursday night and is higher early Thursday as investors consider whether it will benefit from AI-driven advertising, like Meta. Apple has been late to the AI party, but its spending is increasingly focused on driving services and advertising revenue through its massive installed base.
If Apple can demonstrate that its AI integration (such as the rumored Gemini-powered Siri) will drive higher-margin service revenue, it could follow Meta's lead.
In addition to earnings reports, investors will also be focusing on a potential government shutdown this weekend. More weakness in the dollar, a parabolic move in precious metals, weak Bitcoin, potential military action in Iran, and an eventual Supreme Court ruling on tariffs are all creating a complex backdrop.
It will be a challenging market environment with many crosscurrents, but that is what creates new opportunities. Stay focused on the price action and watch for rotations to gain momentum.
At the time of publication, Rev Shark was long GOOGL and AMZN.
