(Bloomberg) -- Enthusiasm for artificial intelligence has powered a breakneck rally in US equities this year, overshadowing the Federal Reserve’s hawkish stance. So how should investors sort out the fundamentals from the hype?

Mark Baribeau, the head of global equity at PGIM’s Jennison Associates, joined the What Goes Up podcast to discuss how he’s viewing the opportunity. He’s the lead manager of the PGIM Jennison Global Opportunities Fund, which is beating 99% of its peers with a more-than 30% gain so far in 2023. 

“The infrastructure layer that allows for this accelerated computing to go on is the way to play AI right now. Because we’re in the R&D phase, the applications are just getting developed,” Baribeau says. 

Here are some highlights of the conversation, which have been condensed and edited for clarity. Click here to listen to the full podcast, or subscribe on Apple Podcasts or wherever you listen.

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Q: The megacap stocks are dominating the gains. How do you approach that as a fund manager? 

A: There’s a couple reasons behind it. One, we started the year at very low valuation because of what happened last year. Secondly, these companies are generating among the highest levels of free cash flow you can find in the global stock market, and that’s one of the reasons investors are flocking to them. It’s because you don’t have to take a lot of risk to participate in a market rally. And investors still are a little wary about what’s happening out there because the Fed has tightened so much. So I’m not saying there’s a flight to safety, but there’s a flight to quality. And so they’re benefiting from that. 

And then of course, the AI boom has ignited a catalyst for future growth — and that catalyst really wasn’t here a year ago. We didn’t know where the next wave of investment spending would occur. And so that clarity is leading the true companies that benefit from it to lead the market, and then other things are participating. And so what I would say right now is, as we go into earnings season this summer and go into the fall, you’ve got to be careful because you don’t want to be exposed in stocks that participated in the rally but in reality have nothing new to offer the marketplace because those will probably correct.

Q: How are you thinking about AI as far as separating the hype from where the true prospects are?

A: The infrastructure layer that allows for this accelerated computing to go on is the way to play AI right now because we’re in the R&D phase. The applications are just getting developed and it’s going to be a tectonic shift in technology for the next decade. It’s the biggest thing to happen since the mobile internet. And so we’re very excited about it. But the best way to play it is through the infrastructure required to do this computing. So that starts with high-end semiconductors, it starts with cloud-based computing workloads, and I think investors will do quite well in that. And then as we move forward, you’re going to see more and more software applications embed this technology — that’s already starting, but it’s going to accelerate over the next year. This isn’t a long-term thing. You’re not going to have to wait three to five years to see what happens. It’s going to start to come into every application — that’s important for productivity purposes in the next four quarters. 

And then we’ll start to see separation, like who’s got the winning formula, who’s developing unique applications that we couldn’t even dream of. It may be old companies or may be new companies, we don’t know. But what’s important is that this is a real advancement in technology. It’s going to be utilized aggressively. And so I think investors should definitely try to position for it. 

Q: How do calls for a recession play into the outlook for growth stocks? If we do see a deterioration in the data rise in joblessness, slower GDP or even negative GDP, how big of a risk is that to the AI theme and the capital spending that goes along with it? 

A: On the recession outlook — the recession’s been pre-announced four or five times every quarter here. So maybe it happens, but we had a big downturn in home construction last year, we had a big downturn in Silicon Valley last year. So you’ve had these rolling recessions in different segments of the marketplace over the last year. And so far this year, what have we created? 1.7 million new jobs? That’s not a recession. It’s steady state, slow growth fueled by a powerful job market. So we probably do get a soft landing. I think that’s what the market is coming around to believing. 

Now, what does it mean for growth stocks? It’s really bullish for growth if you go into a soft landing because the average company is seeing a slowdown in its earnings, whereas growth companies will be putting up hopefully, on average, double-digit earnings growth. And that’s quite a differentiator in a slowing uncertain market environment. And that’s indeed what we’re seeing in our portfolios. We looked at this data the other day because we had just gone through a big earning season. And for the first quarter, the weighted-average growth in the portfolio was around 15%. For the S&P 500, it’s 3.2. So you’re finally getting rewarded for that growth once that big reevaluation reset occurred last year. 

--With assistance from Stacey Wong.

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