Rudi’s View: What About The AI Bubble Anxiety?

Rudi's View | 10:00 AM

'Bubble' or mostly 'misunderstood'?

The debate about the AI megatrend rages on with plenty of oomph and gusto -- globally.

By Rudi Filapek-Vandyck, Editor

Post-August price action for AI beneficiaries on the ASX, including for Goodman Group ((GMG)) and NextDC ((NXT)), shows investors locally remain reluctant to take a firm view either way.

(No such hesitance seems apparent when looking at shares in Megaport ((MP1)).

Meanwhile, technology analysts are preparing for AI shifting into its next phase --coined 'inference'-- when AI adoption will spread across ever more segments and sectors that make up the broad economy.

As stated by analysts at Morgan Stanley recently:

"In a world where AI eventually becomes commonplace, the inference phase sees the deployment/adoption of AI models to use cases across both consumer and enterprise.

"This phase harbours significantly more interesting and long-dated potential and is still currently in the very early stages."

That view coincides with the observation Australian businesses have only just started to embark on their own AI journey with this year's August results season the first to see AI being mentioned regularly and in notable numbers.

In similar vein, it was only less than a month ago TechnologyOne ((TNE)) presented its world's first fully embedded AI ERP software product, to be officially launched in Q1 next year.

Last week's investor day by insurer Suncorp Group ((SUN)) was equally dominated by digital transformation and sizeable investment in AI capabilities.

As I suggested during my recent on-stage presentation to Sydney members of the Australian Investors' Association (ASA):

The blunt statistics assure us about half of all marriages ultimately ends in divorce.

This still doesn't mean our advice to all newlyweds should be: get a lawyer, now!

Goldman Sachs and the AI bubble anxiety

Within this context, analysts at Goldman Sachs put together a sizeable report, including interviews with expert voices from outside the firm, in an educated attempt to determine whether AI is in a bubble or not.

Don't look for an ironclad answer as the views shared and conclusions drawn remain polarised and diverse.

But the report contains many valuable insights to ponder and will no doubt make its way around the world to be read by investors looking to update their own ideas and perception.

Below are excerpts from the Goldman Sachs compilation, complemented with my own views and observations.

Enjoy.

Investors are worried

Goldman Sachs: AI bubble concerns are back, and arguably more intense than ever, given a number of (worrying?) developments: a significant rise in the valuations of many AI-exposed companies, continued massive investments in the AI buildout, and the increasing circularity of the AI ecosystem, with model companies, infrastructure providers, and hyperscalers signing deals with each other that are blurring the boundaries between customers, suppliers, and capacity providers.

Amid these developments and growing worries that the megacap tech rally may be masking signs of weakness in the broader market, whether AI bubble concerns are warranted --or overblown-- is Top of Mind.

We first ask GS US equity analysts Eric Sheridan (internet) and Kash Rangan (software). Sheridan notes that while some features of the current period rhyme with past bubbles, and the circularity of deals warrants caution, public market valuations and capital market activity levels remain below their Dot-Com peaks.

He also points out that most of the Mag 7 continue to generate outsized free cash flows, engage in stock buybacks, and pay dividends -- behavior seldom seen during the Dot-Com Bubble. So, he seems less inclined to call the situation in the public market a bubble today, though he concedes that AI may just not be a bubble yet.

Rangan, for his part, sees few signs of a bubble in his coverage universe with many software valuations --if anything-- too depressed. He more broadly worries about companies increased reliance on debt to fund their AI ambitions.

FNArena: A large majority of 'the end of the AI bubble is near' scaremongering that is spreading like a wildfire across social media platforms and into mainstream publications is based on the observation all prior technological break-throughs throughout history have triggered boom & bust cycles.

Hence, the modern-day megatrend by definition must follow the same script.

A lot of the critiques and warnings stem from ultra-simplistic cherry-picking of charts and data, with facts often misunderstood or misinterpreted.

Give a man a hammer and he starts looking for nails to hit, nest-ce pas?

In all fairness, the numbers involved they do look gigantonormous, but today's economies are much larger than those from the past and so are the key companies behind most investments made.

Combine this with AI requiring a significant build-out of cloud and compute infrastructure and one should expect today's numbers to be really, really large.

Does this equal zero return on investment or by definition an abysmal return?

I'd argue there's only so much that can be modelled and forecast in the early stages of new tech developments (hockey sticks do not combine well with linearity).

At the same time, megatech companies such as Alphabet, Meta and Microsoft are not that worried about returns on their infrastructure build-outs; they have higher goals, and so do governments in Washington and Beijing who fear outright obsolescence.

Simply put: this new megatrend is much more complicated than a simplistic one-on-one comparison with railroads or the Internet.

Key question; what if 2025 turns out to be the historical equivalent of 1995 or 1925?

Are we going to scream 'bubble, bubble, troubles everywhere' for another 4-5 years and then claim we were 'right' by the time the trend ends (assuming there's a crash at the end of it)?

History shows if AI truly builds into the next mega-bubble, and then crashes, there won't be many places for investors to hide.

Those who've lived through the GFC and the Nasdaq meltdown know exactly what I am referring to.

Be careful what you wish for.

Every multi-year bull market leads to pockets of exuberance and risk-taking excesses, and this time is no different.

But as again shown in the Q3 results season in the US, rumours about the death of the AI trade/trend are yet again greatly exaggerated.

In a comical twist, the more scepsis among investors about the validity and duration of the AI megatrend, the less likely it will quickly build into a megabubble that will destroy itself.