This week Nvidia hit a $5 trillion valuation. That puts it at more than twice the size of the entire FTSE 100. Whether or not AI is a bubble about to burst, or in the foothills of a multi-decade boom, has become the defining question for markets. Unfortunately for investors, the arguments are strong on both sides.
Part of the problem is AI’s dominance in the market. Technology forms around 35% of the S&P 500, almost 2.5x that of any other sector*. Only one of the top 10 companies in the index is not technology (Berkshire Hathaway)* and all of the technology companies are connected in one way or another to the AI trend.
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Investor caution
James Thomson, manager of the Rathbone Global Opportunities fund, says: “Thirty of the most AI-centric stocks account for almost all the S&P 500’s year-to-date gains. Approximately 43% of the S&P 500 has been labelled an ‘AI stock’ according to analysts at JPMorgan.”
Some influential people are starting to worry that the AI fervour has gone too far. Jamie Dimon, CEO of JPMorgan Chase, warned in a recent interview with the BBC, “Any way you measure equity valuations, they’re high – 85-90% of historic levels. Bull markets can go on a lot longer than you think, but it creates another element of risk. It’s been created by the money that’s been thrown into the financial system since Covid: there’s been $10 trillion of additional federal debt.”
The bull case: a technological revolution
The bull case for AI is that it will bring about a revolution every bit as significant as the internet. It will change the way people live and work, bring about vast productivity benefits that will more than justify the billion dollar investment. The Financial Times reported that Google, Meta and Microsoft have spent an eye-watering $80bn over the last quarter on artificial intelligence infrastructure**.
Proponents argue that the path of top-performing companies is seldom smooth and investors need to stay invested to reap the benefits. Lawrence Burns, fund manager at Baillie Gifford, points out: “Great companies are always trying to do something that has never been done before, and there are times when people will question that path and their progress. The journey is often bumpy.”
He gives the example of Nvidia, which has been a huge stock market success: “But people forget the journey has been difficult – if you go back to 2022, the share price fell 60-70%. You don’t get the underlying return if you sell out at the first sign of difficulty. It’s a feature of the path that companies go through.”
With AI, while there may be overspend, he believes organisations could repurpose that capital equipment to do other things if necessary.
Balancing euphoria and risk
This stance is typical of many fund managers. They recognise that AI will be revolutionary, but are struggling to justify valuations. James Thomson at Rathbones says: “We are firm believers that AI is a new computing generation that will probably be the most important investment theme of our careers. But we want to keep euphoria and our risk exposure to this theme in check. Era-defining technological inventions are often accompanied by hype, over-investment, unclear business models and snake oil salesmen.”
At the moment, he has around 20% of the fund exposed to this AI theme and has been careful to trim position sizes into strengths — most recently with holdings in high-end chip designer Nvidia and connectors, wiring and sensors supplier Amphenol***.
He points out that the tech (and tech-related) super sector is now almost 60% of the market, while traditional cyclicals have flatlined and defensives were crushed. “We want to remain broad and balanced in our end-market exposure as even the AI theme will run into indigestion that could trigger a meaningful correction.”
The bear case: is this the next Dotcom bubble?
At the other end of the scale are those that are nervous about the AI boom, preferring to look for value in areas where growth is more assured. Hugh Grieves, manager of the Premier Miton US Opportunities fund, for example, says that there are parallels with the internet bubble of the late 1990s: “We are witnessing many of the aspects that drove the Dotcom boom repeating throughout today’s stock market, including lofty valuations (especially of loss-making companies), huge capital investment to support expected future demand, and equipment vendors providing financing to customers to complete sales.”
He admits that predicting when the bubble might end is difficult. “Shares of companies that are not exposed to the AI euphoria have struggled, both with investors’ attention as well as with the wider economic backdrop. The split between ‘new economy’ and ‘old economy’ stocks has created a ‘K-shaped’ market in which performance between the two has diverged sharply. However, we believe that investors have now become excessively optimistic about the outlook for AI-related stocks and that there are significant risks building in the US stock market.
“But with the excessive optimism in some areas, comes excessive pessimism in others. This is creating new opportunities for us to invest in companies that we have admired for years but not until now have we had the opportunity to buy at prices that we find attractive.”
There is no easy answer on whether AI is in a bubble, or if it is, when it will end. Investors can protect themselves through diversification, balancing any US technology exposure with unloved areas such as the UK, or by ensuring that they are with capable managers who can steer them through the volatility.
