Welcome to the AI Bubble and beware…
Two of the most recent investment bubbles were the dot-com bubble in the United States (1996-2000) and the housing bubbles that emerged around 2006 in different countries.
Both ended in recession – the former relatively mild, and the latter catastrophically bad.
Bubbles occur when stocks surge on inflated growth expectations that ultimately prove to be disconnected from a company’s underlying fundamentals, a painful reality check that typically ends with overhyped shares falling back to Earth.
We’ll know more tomorrow morning (Thursday) when Nvidia posts its earnings.
Economists are questioning whether AI will turn out to be as transformative for businesses as proponents of the technology insist. It may in the long run but not now.
Asian shares retreated recently following Wall Street’s tumble to one of its worst days since April, as Nvidia and other AI superstar stocks dropped on worries their prices are too high.
Nvidia was the heaviest weight on the market after the chip company fell 3.6%. Other stocks swept up in the AI frenzy also struggled, including drops of 7.4% for Super Micro Computer, 6.5% for Palantir Technologies and 4.3% for Broadcom.
Questions have been rising for some months on how much higher AI shares can go following their already spectacular gains. Early this month, Palantir had gained nearly 174% for the year so far, for example.
The dizzy increases in stock prices of AI-related companies have got many investors asking “are we witnessing another asset price bubble?”
Everyone from bank bosses to the IMF has warned about the stratospheric valuations of America’s tech companies.
You bet as over the last week or so we are seeing a sell off of AI stocks. The bubble bursts when almost everyone wants to sell
The stock price of Nvidia – which manufactures many of the computer chips that power the AI industry – has multiplied by 13 since the start of 2023.
Stocks in other AI-related companies like Microsoft and Google’s parent company Alphabet have multiplied by 2.1 and 3.2, respectively.
In comparison, the S&P 500, which tracks the stocks of the most important US firms, has multiplied by just 1.8 in the same period.
It is important to emphasise that these AI-related companies are included in the S&P 500, making the difference with non-AI companies even larger.
A bubble cannot stay inflated forever. It has to either burst on its own, or, ideally, be carefully deflated through targeted government or Central Bank measures.
Theis AI bubble bursting may be more painful because more households participate (either directly or indirectly via mutual funds) in the stock market than 20 years ago.
That brings the loss home.
One major problem is we don’t know how the financial system will react if these huge AI companies default on their debt.
Alarmingly, this seems to be how they are currently financing new investments – a recent Bank of America analysis warned that large tech companies are relying heavily on debt to build new data centres, many of which are to cover demand that doesn’t exist yet.