Many investors are constantly on the lookout for the next big investment theme. Right now, that theme is arguably artificial intelligence (AI). With tech giants pledging billions in AI investments and the market buzzing with excitement, it's natural to wonder: Are we witnessing the birth of a transformative technology, or are we caught in the throes of a speculative bubble?
The Staggering Scale of Investment
The sheer magnitude of capital being poured into AI is breathtaking. Tech giants and other companies are estimated to spend around $1 trillion on AI capex in the coming years. This includes significant investments in data centers, chips, and other AI infrastructure.
As the below chart illustrates, Microsoft's AI capex intensity is already outpacing its cloud buildout. This level of investment raises questions about potential overexuberance and the risk of capital misallocation.
The Revenue Gap
Despite the massive investments, there's a growing concern about the gap between AI infrastructure spending and actual revenue generation. This gap has widened significantly since September 2023. What was recently dubbed as "AI's $200B question" has now ballooned into "AI's $600B question." This idea was recently discussed by Sequoia Capital in a recent blog post.
To put this in perspective, the revenue expectations implied by the current AI infrastructure build-out far exceed the actual revenue growth in the AI ecosystem. This discrepancy raises serious questions about the sustainability of current investment levels and the timeline for realizing returns.
The Productivity Promise vs. Reality
AI enthusiasts argue that the technology will drive significant productivity gains. Goldman Sachs economists estimate that generative AI could boost US productivity by 9% and GDP growth by 6.1% cumulatively over the next decade.
However, skeptics like MIT economist Daron Acemoglu offer a more conservative outlook, forecasting only a 0.5% increase in productivity and 0.9% increase in GDP over the same period. This stark contrast in projections highlights the uncertainty surrounding AI's economic impact.
The "Killer App" Conundrum
Despite the massive investments, we've yet to see a clear "killer application" for AI that justifies the current spending levels. While there have been impressive demonstrations and efficiency gains in certain areas, the technology is still searching for its defining use case that will drive widespread adoption and generate substantial returns.
Interestingly, OpenAI's ChatGPT remains one of the few AI products generating significant revenue, with recent reports suggesting annual revenue of $3.4 billion. This concentration of success in a single product underscores the challenges faced by other AI startups and companies in monetizing their offerings.
Infrastructure Bottlenecks and Oversupply Risks
The AI boom is putting immense pressure on critical infrastructure, particularly in two areas:
Chip Supply: While there were significant shortages in late 2023, the supply constraints for AI chips have largely subsided. However, this has led to a new concern: growing GPU stockpiles. As major tech companies continue to invest heavily in GPUs, there's a risk of oversupply, which could lead to rapid depreciation of these assets.
Power Demand: The proliferation of AI and data centers is driving a surge in power demand not seen in a generation. Utilities may struggle to meet this demand, potentially constraining AI's growth.
This chart illustrates the expected surge in US power demand, largely driven by data centers and AI.
Valuation Concerns and Market Dynamics
The AI enthusiasm has pushed valuations of many tech stocks to elevated levels. Nvidia's recent ascent to become the world's most valuable company exemplifies this trend. While not yet at the extremes seen during the dot-com bubble, current valuations suggest investors are pricing in significant future growth and profitability improvements.
However, investors should be cautious. The AI computing market is increasingly becoming commoditized, with low barriers to entry and limited pricing power. This could lead to fierce competition and margin pressure in the future.
The Long Game and Historical Parallels
History shows that transformative technologies often take longer than expected to deliver on their promise. The internet, for example, took years to generate substantial returns for many companies. Investors need to consider whether they have the patience and risk tolerance to weather potential short-term volatility for long-term gains.
The analogy of AI infrastructure to railroad building is intriguing but flawed. While both represent significant infrastructure investments, AI lacks the monopolistic pricing power that railroads enjoyed. Moreover, the rapid pace of technological advancement in semiconductors means that today's cutting-edge AI hardware may depreciate much faster than physical infrastructure.
Winners and Losers in the AI Era
As with any technological revolution, there will be winners and losers in the AI era. While some investors may face losses due to overvaluation or misallocation of capital, the overall trend of declining costs for AI compute power could be a boon for startups and innovators. Companies that can effectively harness AI to deliver real value to end-users are likely to emerge as the long-term winners.
In conclusion
While AI undoubtedly holds immense potential, the current investment landscape is fraught with both opportunity and risk. The technology is still in its early stages, and it's crucial for investors to approach AI-related investments with a clear-eyed view of both the possibilities and the pitfalls.
The road ahead for AI is likely to be long and filled with ups and downs. The current phase of speculative investment and infrastructure building may lead to short-term inefficiencies and potential losses for some. However, it's also laying the groundwork for what could be a generation-defining technology wave.
DISCLAIMER
Royce Advisory Pty Ltd (ABN 43 622 402 706) is a Corporate Authorised Representative (CAR) of MB Capital Partners Pty Ltd (AFSL 536053). This article, commentary and discussion is general information only and is not intended to provide you with financial advice as it does not consider your investment objectives, financial situation or particular needs. You should consider whether the information is suitable for your circumstances and where uncertain seek further professional advice.
This communication is based on information from sources believed to be reliable at the time of its preparation (July 2024). However, despite our best efforts, no guarantee can be given that all information is accurate, reliable and complete. Any opinions expressed in this email are subject to change without notice and neither Royce Advisory or MB Capital Partners is not under any obligation to notify you with changes or updates to these opinions. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.
Comments