It’s no secret that excitement surrounding artificial intelligence (AI) has helped propel the US stock market to new record highs. The S&P 500 is trading close to its 52-week high, and it’s a similar story for the Nasdaq 100.
However, with billions being poured into AI spending, there’s a growing concern that the technology isn’t delivering its promised returns. So much so there’s speculation that an AI bubble is forming. And should it burst, it could trigger a fresh stock market crash akin to the dotcom bubble in the late 1990s.
Is AI in a bubble?
Stock market bubbles occur in five stages:
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- Displacement
- Boom
- Euphoria
- Profit-Taking
- Burst
If AI’s in a bubble, there’s a good chance it’s currently in the Euphoria stage. This is where excitement’s driving valuations over fundamentals, pushing prices to record highs on the back of lofty performance expectations. There’s already some evidence of that when looking at stocks like Nvidia (NASDAQ:NVDA).
AI spending’s created incredible demand for the chip-designer’s AI accelerators. This has resulted in revenue and earnings skyrocketing, taking the group’s share price with it. In fact, in just the last five years, Nvidia’s share price has surged by over 2,500%!
The group’s stellar business performance continued last month when the company reported its third-quarter earnings. Revenue growth came in at 93%, paired with expanding profit margins that pushed net income up by a jaw-dropping 109% year-on-year.
Normally, that would be a celebration among shareholders. Yet, triple-digit earnings growth actually just wasn’t good enough to meet expectations, resulting in a muted reaction from investors followed by a near 10% sell-off within a few days. If this is the start of the profit-taking stage, the AI bubble could be about to burst.
Is this a new dotcom bubble?
High-profile bearish investors like Jeremy Grantham have started drawing parallels between the AI bubble and the dotcom bubble. However, these concerns seem a bit overblown, in my opinion.
There’s no denying that valuations are getting quite rich. But most AI stocks are already generating revenue, with some like Nvidia being extremely profitable as well. By comparison, most internet stocks in 1999 were pre-revenue start-ups with no proven applications across the burgeoning market.
But let’s assume the worst – AI’s a bubble. How and when will it burst? The how is simple and will likely follow one of two scenarios:
- Investors start coming to their senses and start withdrawing funds gradually. This would translate into a steady correction, with value-creating AI stocks remaining strong while speculative businesses get filtered out
- A high-profile AI company suffered a sudden growth slowdown, triggering panic across the entire sector and resulting in a market crash
However, when this might happen is anyone’s best guess. It might not even happen at all. Bullish sentiment surrounding AI is that the technology has barely made a scratch in unleashing its value-building potential.
And suppose AI spending starts delivering on its promised returns? In that case, today’s high valuations begin to look justified, resulting in no stock market bubble at all. Personally, I’m sitting firmly in the camp of wait and see.
