🎈 Are we experiencing an AI bubble?

Tech stocks will go up and down, but truly important technologies abide

Quote of the Issue

“The remaining two or three percent of the world's population, however, are no longer people of either the past or present. For within the main centers of technological and cultural change, in Santa Monica, California and Cambridge, Massachusetts, in New York and London and Tokyo, are millions of men and women who can already be said to be living the way of life of the future.” - Alvin Toffler, Future Shock

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The Essay

🎈 Are we experiencing an AI bubble?

Technology and technology stocks are two different things. An investment boom, bubble, and bust in a certain technology sector because of the emergence of a new kind of tech doesn’t mean that tech isn’t as significant as first hoped. A brief survey of American economic history over the past century shows as much. New tech repeatedly led to cycles of rapid growth and decline in various sectors. Both huge consumer demand and wild investor speculation drove up the number of companies and their valuations before the seemingly inevitable crash. Among them:

• Radio. Massive demand for radios after World War I resulted in a proliferation of radio stations and manufacturers, such as RCA, which saw its share price increase by a whopping 10,000 percent in the 1920s. But the radio sector collapsed by 98 percent between 1929 and 1932 — the Great Depression didn’t help — and most radio manufacturers failed. Yet radio remains a hugely important technology.

• Personal Computers. IBM was “Big Blue” and the big dog in the computer market back in the 1980s, but it was hardly alone. There were lots of players, including both PC and video game console makers such as Atari, Coleco, Commodore, and Texas Instruments. But in 1983, several companies in the sector announced losses, share prices collapsed, and many PC manufacturers went out of business. Yet PCs remain a hugely important technology.

• Internet. This one many of us remember quite clearly. Back in 1996, Yahoo! had a massive initial public offering with the stock jumping to $33 from $13 on its first day of trading. The Nasdaq composite index, home to the hottest tech stocks, increased fivefold over the period between 1995 and 2000. But the internet bubble burst in 2000, causing a massive decline in the value of hundreds of companies and the Nasdaq index, which fell by nearly 80 percent by 2002. Yet the Internet remains a hugely important technology, especially the PC + Internet combo.

Radio, PCs, and the internet are just three among many technologies that have been accompanied by financial bubbles since the start of the Industrial Revolution, although those three are used as examples by Goldman Sachs in the new analysis, “Why AI is not a bubble” by its global strategy team. From that report:

Radical new technologies tend to attract significant capital and competition, and many companies eventually collapse, but this does not mean that the technology itself fails. It is more common for the initial technology to succeed as take-up and market grow, and dominant companies innovate to broaden the scope and reach of the technology. The adoption speed of technologies has tended to accelerate over time as real incomes have increased and geographical reach has grown more rapidly.

As a rule, the pattern of changing market structure tends to be similar in different waves of innovation; initially, the space is typically dominated by a few winners that become increasingly powerful as the network effect generates a virtuous cycle of growing market share and as they build increased ‘moats’ that sustain their dominant position. These dominant positions are ultimately vulnerable either to regulation (antitrust) or slow adaption to innovations. …

So, while the leading tech companies of the 2020s will most likely remain dominant in their respective markets, rapid innovation, particularly around machine learning and AI, will likely create a new wave of tech superstars and possibly products and services that are not yet imagined. It is probable that AI and robotics will not only create innovative leading companies but will also raise the prospect of major restructuring gains in non-technology sectors.

Whatever happens to the stocks of companies that make AI chips and manufacturing equipment (such as Nvidia and Marvell), run the cloud computing infrastructure for large-scale AI commercialization (such as Microsoft, Alphabet, and Amazon), and use AI to boost their businesses (such as Meta and Salesforce), AI/machine learning/deep learning/generative AI should have staying power. That, especially if the early studies of productivity impacts continue to be borne out.

But what about the stocks getting a boost due to AI enthusiasm? Do their high market valuations spell b-u-b-b-l-e?