A New Story
Artificial Intelligence stocks have been making the news once again, but not in the way that we have become accustomed to. Rather than being another tale of how AI is changing the world and how the stocks involved easily justify their sky-high valuations, it is instead a story of how hype and enthusiasm can blind investors to questions of justifiable valuations, which can then have dramatic consequences when assumptions are found to be built on shaky ground. As a result, the tech-heavy US NASDAQ index fell 3% yesterday, while the poster child company of AI, Nvidia, fell 17% in value.
This market rupture follows the announcement last week that a young Chinese technology firm, DeepSeek, has developed an AI model that can perform to a comparable level as the established names in this space, such as OpenAI’s ChatGPT. The emergence of a similar quality product might not be such a shock to the system if it wasn’t for the fact that it has reportedly been developed for just $5.6 million and using a relative handful of not even the latest processor chips from Nvidia. This compares to the many billions of dollars other firms have been spending in order to get to this level.
Rise of the Hyperscalers
Since the first release of ChatGPT in late 2022, large technology companies, such as Google, Microsoft, Apple, Amazon, and Meta (known as the ‘hyperscalers’) have been in an arms race to spend huge volumes of money on AI chips. This has led investment markets to handsomely reward both these stocks, assuming that the companies with the biggest AI investment will ultimately enjoy the biggest revenues; and the company selling them the chips, Nvidia, which has gone from being primarily known in the videogame sector to being, at one point, the most valuable company in the world.
The share prices of all these companies have surged over the past two years, with investors seemingly uninterested in metrics showing them to be at historically elevated valuations, believing the future is only going to get brighter for them. However, in our view, these prices have been stretched and the level of excitement around these stocks has been bordering on mania, reminiscent of previous stock market bubbles, such as the dotcom boom and bust at the turn of the millennium.
The Warnings Have Been There
This is a topic we have written about in previous commentaries and is an area that has been carefully managed in the investment portfolios managed by Future Money. Exposure has been limited to these AI names given concerns of bubble like prices, with a focus instead on other areas that can benefit from US economic strength, but which are at more attractive valuation levels.
This is a short-term story so far, and with after-hours trading suggesting a slight recovery in the most affected stocks, it is possible this is a mere blip in the charge higher. Yet even if it is, this should be taken as a clear warning of what can happen when market narratives change. AI is likely to change the world and lead to great productivity gains, but as the billionaire hedge fund manager, Ray Dalio, said in today’s FT, “some people are confusing that with the investments being successful”.
Pleasingly for investors, broader markets performed reasonably well yesterday, but those focused on AI, which have experienced the largest gains of recent years, fell dramatically. This should be taken as a caution to consider valuation levels and not just an exciting story when making investment decisions.