The AI arms race has been ongoing for the past three years, and it doesn't look to be slowing down anytime soon. However, with multiple massive deals getting announced over the past few weeks, investors are starting to get a bit concerned that we could be in a stock market bubble. Although many investors (including me) are too young to remember the dot-com bubble in the early 2000s, it's important to study it to ensure investors don't repeat the same mistakes.
However, there is also the possibility that this isn't a bubble and that all of the money being spent in this realm will amount to real economic gains over the long term. So, what should an investor do? Let's take a look.
Image source: Getty Images.
Circular investing is becoming a problem again
One of the biggest contributors to the dot-com crash was circular investing. This occurred when one company invested in another in exchange for a product to accelerate the buildout of the internet. The idea was that as long as valuations remained elevated, this financing method would work and would eventually be followed by massive consumer demand that would subscribe to an internet service, making all of these investments worth it. However, valuations plummeted, sparking a massive sell-off in the stock market.
This is eerily similar to what's happening today. OpenAI, the maker of ChatGPT, is recognized as the leader in generative AI technology. It has announced multiple deals with Nvidia (NVDA 0.44%), AMD, Broadcom, and Oracle, and all of them are financed in a way that doesn't involve OpenAI paying cash (or taking out debt) that is backed by massive consumer or business demand. This is what's driving the fears of an artificial intelligence-driven stock market bubble.
NASDAQ: NVDA
Key Data Points
The biggest trap that investors can fall into is "this time is different." However, I think there are a few key differences in this buildout versus the dot-com buildout that investors must be aware of.
Not every company would be affected by a crash
The AI hyperscalers are all spending a vast amount of money on AI infrastructure. However, if that were to stop suddenly, these companies wouldn't be affected by it. Take Alphabet for example. It gets the majority of its revenue through the Google Search engine. If the AI arms race were to come to a halt, its core business wouldn't be affected; it would just stop spending a large chunk of its cash flows on AI. The same could be said for Amazon, Microsoft, and Meta Platforms.
NASDAQ: GOOGL
Key Data Points
However, companies like Nvidia would be heavily affected, as the demand for its graphics processing units (GPUs) would no longer be there. As a result, not every big tech company would be harmed over the long term by a crash, even if its short-term stock price declines.
There's also the possibility that the AI arms race provides real economic value in a timeframe that is reasonable. The internet buildout eventually occurred in the decade following the dot-com crash and brought huge economic value to the world. However, it wasn't at the pace investors envisioned it occurring in the early 2000s. Time will tell, but with the pace of AI adoption in the business world and among consumers, I'd expect generative AI to continue providing tangible value over the next few years.
While I believe valuations are starting to get a bit frothy for some companies, especially in the private sector, we're still OK overall. Yes, the market is valued at all-time highs, which could limit return potential, but if the AI data center buildout trend continues like many projects (in the multitrillion-dollar range by 2030), there is still a ton of room for AI-related stocks to run. Furthermore, the AI hyperscalers mentioned above are all growing their revenue in the mid-double digits, and that's without any real benefit from AI.
Investors should be diligent in managing their cash balance and exposure to AI stocks, but running for the hills based on a few worries of Wall Street analysts is an irrational move.
