The Looming Pullback in AI Stocks
The recent surge in the stock market has been driven in large part by the extraordinary rise of artificial intelligence (AI) stocks. But the AI bubble may be on the cusp of bursting. Whispers of an impending pullback are growing louder. Many experts are warning that the AI-driven rally could be heading towards a significant correction.
The AI Frenzy: A Catalyst for Market Growth
AI’s role in propelling the stock market cannot be overstated. The AI revolution gained unprecedented momentum following the launch of OpenAI’s ChatGPT in November 2022. This groundbreaking chatbot sparked a global race to develop AI technologies. And ignited massive demand for Nvidia’s graphics processing units (GPUs). As a result, Nvidia’s market value soared. It surpassed the $3 trillion mark, putting it in the same league as tech behemoths like Apple and Microsoft.
The broader market also benefited. The S&P 500 gained 15.29% in the first half of 2023, largely due to AI-related stocks. The “Magnificent Seven” tech giants, including Microsoft, Apple, and Nvidia, led the charge. They returned about 60% through the first eight months of 2023. Nvidia saw its stock surge 150% in the first half of the year. However, when Nvidia’s performance is excluded, the S&P 500’s return drops from 15.29% to 10.72%, underscoring the outsized impact of AI on the market’.1
Growing Skepticism: A Bubble on the Horizon?
Despite the impressive gains, skepticism about the sustainability of the AI boom is mounting. David Cahn is a partner at Sequoia Capital and a key figure in AI investments. He has expressed concerns about the ongoing AI bubble. In a paper published in June 2024, Cahn warned that the AI market might be approaching a tipping point. Revenue is not matching the massive spending on AI infrastructure.
Cahn determined that if Nvidia’s data center revenue reaches $150 billion by year-end, the companies investing in Nvidia components would need to generate $600 billion in revenue to justify their expenses. 2
Adding to these concerns is the slowdown in GPU demand. While 2023 saw a supply shortage, stockpiles are now growing. AI-only companies are seeing minimal revenue gains. Even OpenAI, despite its success in reaching a $3.4 billion revenue, is still on track to incur a $5 billion loss this year. Cahn describes the current AI market as a “speculative frenzy.” He predicts that the valuations of companies like Nvidia could experience a huge pullback. Investors may begin to question the sustainability of their investments.3
Concentration in AI Leaders and Valuation Impacts
The rally in AI stocks has been notably concentrated in a small number of companies. Just 15 firms accounting for over 90% of the S&P 500’s returns from January to June 2023. The price-to-earnings (P/E) ratio for U.S. technology stocks reaching the upper end of its 10-year range. Although not as extreme as those seen during the dot-com bubble, the situation is still cause for concern. 4
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Investor Caution: The Market’s Mixed Sentiment
The skepticism surrounding AI investments is not confined to industry insiders. Major tech companies like Alphabet and Microsoft have faced investor pushback. Both companies saw their stock prices drop following earnings reports. Investors are growing concerned among the long-term viability of their AI strategies. This sentiment is echoed by financial institutions like Vanguard. They caution that the technology’s near-term potential may be overstated. Vanguard estimated that AI stocks would need corporate profits to grow by 40% each year for the next three years to justify their current prices. That rate that is double what was seen during the 1920s, when electricity was revolutionizing the economy. The firm thinks the current market enthusiasm could result in overvaluation. This might lead to a big drop in AI stock prices.6
The Potential for a Pullback
Given the current landscape, a pullback in AI stocks seems increasingly likely. The first signs of weakening demand could trigger a wave of sell-offs. This scenario has happened before. Historically, stock markets have corrected when investor sentiment outpaces actual economic performance.
The recent setback in Nvidia’s stock price is a case in point. After releasing its quarterly results, Nvidia’s stock experienced an 8% drop, highlighting the volatility and uncertainty surrounding AI-related stocks. While AI has been a major driver of the stock market’s recent performance, the underlying risks associated with these investments cannot be ignored.
Conclusion
AI’s path forward is likely to be marked by volatility. Investors should be prepared for potential setbacks. Whether the current AI boom will end in a bubble burst or pave the way for unprecedented innovation remains to be seen. However, akin to the dot-com bubble, a bursting AI bubble has the potential to drag down the entire market. To defend against possible losses, advisors suggest moving into safe haven assets like physical gold and silver. A Gold IRA can offer long term protection from AI inspired market volatility. Call us today at 800-462-0071 to learn more.
