AI boom or AI bubble?

Generative artificial intelligence (AI) has been a boon for the market.

Investor excitement about the technology’s potential has been the key driver of the 2023-24 stock market rally. Just look at AI darling Nvidia, which has seen its stock price soar more than 200% in the last year, thanks to demand for its graphic processing units. 

But this extreme and meteoric enthusiasm may also have some investors wondering: How long can this ride last? And are we in an AI bubble?

Why it’s smart to be skeptical

The history of financial markets is dotted with speculative bubbles. From the excesses of the Tulip Mania of the early 17th century to the dot-com era of the late 1990s, episodes like these are often marked by rapid price appreciation and investor euphoria. However, these bubbles inevitably burst, often leaving an enduring scar on the collective psyche of investors.

Recent scars may not be as profound as those received during the market’s most notable boom-bust cycles, but the sheer volume of mini-bubbles or speculative frenzies over the last five years might be instilling a healthy dose of skepticism among market participants toward the current AI boom. The “mini” bubbles of the last five years, encompassing blockchain-based assets, meme stocks, renewable energy, cannabis stocks and SPACs, were characterized by rapid valuation increases, investor euphoria and a fear of missing out (FOMO), all driven by narratives of technological disruption or societal change. Each boom eventually underwent a significant correction as the reality of market fundamentals and the challenges of meeting lofty expectations became apparent.

Are we in an AI bubble?

Against this backdrop, investors are understandably cautious about the ongoing rally in generative AI-related stocks. While history has clearly shown that market sentiment can often outpace reality, we believe the transformative potential of AI is undeniable and that recent price appreciation may be justified.

How AI momentum differs from past investor frenzy

In contrast to the previously described market manias, we believe AI's potential lies in its ability to function as a general-purpose technology, akin to electricity or the internet, with applications across virtually every industry. From health care and finance to manufacturing and transportation, we believe AI has the potential to revolutionize the way we live and work, driving productivity gains and creating new business opportunities.

Absent from the current investing landscape are the numerous small, speculative, money-losing firms that characterized previous bubbles, particularly the dot-com era. In contrast, today's leadership consists of established firms with robust revenue growth and profitability, supporting strong fundamentals. While valuations for many growth stocks remain high, we believe current guidance and forecasts have yet to fully account for multiple scenarios that could sustain current growth rates and further justify premium valuations.

Why mega-cap firms may be positioned for a long-lasting AI boom

Our bull case scenario for AI-related mega-cap firms includes less celebrated but potentially vital elements to maintain significant long-term growth and defend market share. In our view, today's market leaders tend to be uniquely well-positioned to influence two key dimensions of the AI ecosystem: politics and venture capital.

As AI becomes increasingly critical to economic growth, mega-cap tech firms appear well-positioned in political clout and resources to lobby for regulations that benefit their interests. This could include advocating for policies that promote the adoption of their AI platforms, protect their intellectual property and create barriers to entry for potential competitors. While it might be argued that political lobbying is standard practice across many industries, we believe that AI presents a new technological frontier where legislation and regulation remain in the early stages of development. Moreover, we believe that the potential for regulatory capture is heightened in the AI industry, given the technology's complex and rapidly evolving nature, which could ultimately tilt the balance of competition in favor of industry leaders.

In addition to their early influence on the regulatory environment, mega-caps have also leveraged their deep pockets and substantial cash flows to effectively become the go-to venture capitalists in the AI space. As the gatekeepers to expensive yet essential AI development infrastructure, these firms are positioned with the ability and insight to invest early in the most promising startups and technologies. By acquiring or partnering with these innovators, AI pioneers can effectively navigate antitrust concerns while reaping the potential benefits of new advancements in the field. In our view, this strategy could enable today's dominant forces to remain at the forefront of AI development and maintain their leadership market positions. There are numerous high-profile examples of mega-cap tech firms investing in early-stage companies, with today's market leaders showcasing their ability to identify and capitalize on tomorrow's leading developers.

Bottom line: Be cautious, but optimistic about AI’s future

As the AI revolution unfolds, we believe investors should remain focused on companies with sustainable competitive advantages, strong financials and the ability to navigate this complex and evolving landscape. By doing so, they may be well-positioned to benefit from this transformative technology's possible long-term growth and value-creation potential.

Your Ameriprise financial advisor is ready to help

When technology advancements threaten market disruption, it’s important to remember that new investing opportunities can arise. Know that your Ameriprise financial advisor is well positioned to help you to take advantage of any potential opportunities in alignment with your risk tolerance, time horizon and financial goals.