Investors have long had a love affair with U.S. tech stocks, from the boom cycle of the late ’90s and early 2000s that famously ended with the dot-com crash to the AI-fueled heights of Nvidia’s current stock rally. However, affairs often end badly, which can leave investors with both a sore wallet and a broken heart. Artificial intelligence has officially turned the US tech industry into a bubble, and Silicon Valley could be on the verge of another crash, according to analyst’s note from BCA Research Chief Strategist Dhaval Joshi.
“We are in an artificial intelligence bubble,” says Joshi. Luck. “We were stunned by some of the results.”
Few stocks have embodied that wow factor like $1.7 trillion AI chip giant Nvidia, which reported earnings on Wednesday that beat analysts’ expectations. The chipmaker, which a Goldman Sachs analyst called “the most important stock on planet Earth,” reported revenue of $22.1 billion in its latest quarter, compared with estimates of $20.6 billion. Revenue from sales of data center chips used in artificial intelligence models and generative AI applications reflected increased demand and reached $18.4 billion, up 27% from the third quarter and 409% year over year. . Share prices rose 7% in after-market trading, adding more than $100 billion.
“Accelerated computing and generative AI have reached an inflection point,” Nvidia founder and CEO Jensen Huang said in a press release. “Demand is growing globally across companies, industries and countries.”
Although Joshi did not comment specifically on Nvidia, its outstanding results can be seen as evidence in his favor.
According to Joshi’s calculations published last week, the technology sector is trading at a 75% premium to the global stock market. Its explosive growth became the foundation on which much of the growth of the rest of the US stock market was built. managed Nasdaq to near record levels last year, just 6.5% below the November 2021 all-time high. In 2023, the so-called Magnificent Seven, which includes Nvidia, Apple, Microsoft, Alphabet, Meta, Amazon and Tesla, contributed two-thirds of the S&P 500’s total market gains.
And while these returns are impressive and profitable for savvy investors, they are not sustainable, according to Joshi.
Unlike Nvidia, some companies will not be able to meet the market’s high expectations. This can cause problems as valuations and stock prices fluctuate frequently. measured according to expectations as much as these are real results. If big tech companies, which drive much of the sector’s (and the economy’s) growth, fail to meet analysts’ expectations, they could drag other companies down with them. While Joshi cautions against underestimating AI in general, he believes the market is expecting too much productivity gains from the new technology. And when new innovations fail to meet these expectations, the market will punish the companies that created them.
“Since these handful of stocks make up such a huge percentage of the market capitalization, any disappointment will mathematically have an impact on the overall index,” says Joshi.
For the US tech sector to avoid bubble territory, it will have to continue trading at a 10% premium to the market – a scenario that Joshi considers unlikely.
Joshi doesn’t blame the market for valuing tech companies so highly. In fact, over the past 10 years, they have proven their worth by achieving stellar results time and time again. Over the past decade, shares of leading technology companies have risen sharply. For example, since February 2014, Nvidia shares have increased by 14,927%, Microsoft by 964% and Apple by 875%. The numbers pale in comparison to the still strong 163% The S&P 500 has made a comeback over the past 10 years. While he doesn’t believe this will continue, he says it makes sense for the market to continue to value more explosive growth in technology.
“If you get very strong earnings growth over one or two years, the market thinks differently about it: ‘This can’t be sustained.’ So, if anything, you’re giving it a low rating because you’re saying it’s abnormally high earnings. But if the market sees 10 years of outstanding results, it will no longer consider those results abnormal and will expect them forever, says Joshi.
For Joshi, however, the last 10 years of blockbuster revenue growth have been essentially anomalous. Largely because much of this growth was the result of network effects, which allowed a select few firms to grow significantly in size and effectively gain control of the market. Amazon has captured the online shopping market, Google has done the same for search, and Meta has cornered the online communications market, Joshi writes in his note.
“If you have networks, you have winners and losers,” he says. “These winners become natural monopolies, and if you are a natural monopoly, then you are in a very strong position to increase your profits.”
Without clear indications that the network effect will extend into the world of artificial intelligence, these companies will not have the same dominant position, Joshi argues. “The market is saying, ‘Hey, now the torch is going to be passed to generative artificial intelligence, and this trend will continue for the next five to 10 years.’ I’m very cynical about this because there is no network effect in generative AI.”
There is a possibility that some particularly popular AI tools could see network effects if they attract more users because they can learn to do all the tasks they are asked to do.
Even without AI, it appears that the benefits of the network effect may be diminished in the near future due to pressure from elected officials to regulate big tech companies. “The Web 2.0 revolution has reached its limit due to consumer backlash and much tighter regulation of what data you can collect and how you can use it.”
In Europe, the EU has already passed several landmark pieces of legislation designed to break up some of the energy tech giants such as Apple and Alphabet that were already in the market. While in the US, despite lacking a national privacy law, there is an unprecedented level of bipartisan and public support for a series of new laws that would limit the amount and type of data tech companies can collect about users.
But despite the headwinds Joshi sees on the technology horizon, he doesn’t expect the entire sector to collapse as it did during the dot-com crash. In fact, it will continue to outperform the overall market, but at a slower pace. This could still mean serious losses for investors, especially as the market eventually adjusts to the tech sector no longer delivering 100x returns.
Of course, whether the market is in the midst of an AI bubble is still hotly debated. Joshi is not alone in this. Morgan Stanley has warned against the rapid adoption of artificial intelligence to ensure investors don’t have enough land before the bubble bursts. Meanwhile, Goldman Sachs and others argue that soaring yields are not a bubble, but simply a market rewarding the future of technology.
As for what investors should do to mitigate the risks of a possible AI bubble, Joshi has simple advice: Invest in other parts of the market, such as healthcare and luxury goods.