🎈 The AI Bubble

Generative AI is one of the most impressive innovations of my generation. It is also the most overhyped.

As of May 31, 2024, NVIDIA’s stock price has increased ~128%, and to the untrained eye, there is still no sign of the company slowing down. After all, the company reported earnings last week and beat Wall Street forecasts (yet again) by a whopping 10%, bringing in $26B in revenue for the quarter.

The thing is, we’ve seen this play out before, time and time again. Here is the playbook for a typical asset bubble:

1. An exogenous event that virtually no one saw coming sweeps across the market (or in the pandemic’s case, the globe).
2. As a result of this event, there are new winners and losers in the market
3. The winners that benefit from this event seem like “geniuses” and embrace their newfound luck…CEOs get on the mic to talk about the “secret” to their success, and many will explain that this is a “new normal” for their business or that “it’s different this time”
4. Investors, afraid of missing out on the next big thing, pile money into these winning companies driving sky high stock prices and valuations
5. Over the following years, it turns out that it’s not in fact different this time, and whatever is indeed different ended up being overhyped
6. Stock prices fall, companies return to their “old normal,” and the market moves onto the next shiny thing, many investors getting burned in the process

Does this sound familiar? It should. Below is a chart of Zoom’s stock price history, and it is a perfect illustration of this phenomenon. As the COVID-19 pandemic dragged on, it became clearer and clearer that the world would shift to remote work, and the clear market leader in this space was Zoom.

The business saw a surge in revenues, and positioned this level of growth as a “new normal.” Remote work was here to stay, Zoom would make lots of money as a result, and investors sent their stock up almost 800%. So what happened?

The world did in fact adopt this new normal. Remote and hybrid work is here to stay, and many organizations use Zoom to make this happen. But as it turns out, even with everything in Zoom’s favor, a 9-times increase in their market value was unjustified.

This is the case with NVIDIA and AI companies at large today. While Generative AI is no doubt a remarkable innovation, there is simply too much hype and easy money flowing into these companies to justify even the best case scenario, just like we saw with Zoom and many other Pandemic winners such as PayPal, Block (fka Square), Carvana, Moderna, Etsy, Pinterest, and the list goes on.

While it’s impossible to time exactly when a bubble will pop, it’s still possible to leverage the information we have today to make the best decision possible. I am not brave enough to short NVIDIA stock (after all, the market can stay irrational longer than you can stay solvent), but if I had big gains from this market run-up, I would consider locking in those gains by selling and diversifying into more stable asset classes, such as fixed income, gold, and real estate.