Is there acutally a bubble in AI?
There has been a lot of talk recently about the AI bubble from the talking heads on TV. All the so-called experts claim that there is no way a bubble exists, while others insist that a bubble is definitely present. Who do we listen to and who do we ignore? This is a common question when it comes to investing in general. However, when you factor in the massive popularity of AI, the question becomes a greater concern.
If you have ever seen the movie or read the book “The Big Short,” you have likely heard of Michael Burry. He is currently referring to this as a bubble. I have to agree with him on this one. AI is becoming bigger than we expected, and there is massive investment going into it. Deals are being made almost daily, and many of these companies are collaborating with one another. Some might call it circular finance, while others might refer to it as capitalism. I call it dangerous.
Private equity and Wall Street have dumped billions into AI. Some of these AI companies have not even shown a profit, while others have no revenue to speak of. The product itself can be helpful in certain situations, such as refining an email or formatting a document. On the other hand, advancements in AI are making our kids increasingly dependent on it for everything. The number of kids today who don’t even know how to do basic research is staggering. Schoolchildren are using AI for research on projects and then having AI compile that research into a paper they can submit. This is not helping our kids; it is hurting them.
In addition to the shortcomings in school, kids are using AI chatbots for companionship. The idea that a program is talking to kids and keeping them from actual socialization is crazy. The mental health of our youth should be at the forefront of our minds. However, many parents are not tuned into what their kids are looking at or who they are talking to online. There have been studies that show the AI chatbots are harming our kids socially, and some even say that these chatbots can lead to self-harm in teens and younger kids. If we are not taking care of the kids now, what will happen to them as adults?
OK, back to the point here. Is there an AI bubble? If we examine the bubbles and major market downturns of the past, we will see commonalities in all of them. In recent memory is the .com bubble. Internet companies were starting up all over the place, and everyone wanted a piece of the pie. However, as time passed, we began to see cracks, and investments continued to pour in. These internet companies were overleveraged and had little revenue. To secure additional funding, they went public and began trading on the markets. What happens when public companies start to collapse all at once? A crash followed by a recession. Like in the .com bubble, the housing bubble was fueled by greed. This greed was viewed as a positive development by many people because it made it easier for them to enter home ownership than ever before.
Mortgage brokers were selling people adjustable-rate mortgages (ARMs) with the promise that they could refinance before the balloon payment was due. This is always a great idea in theory, but how often does it actually work in practice? Some buyers wanted to live, or give the appearance of living, a lifestyle bigger than what they currently had, so they took out ARM loans to buy second or third homes. At that point, it became too challenging to refinance due to the number of mortgages on their credit. So banks started to foreclose. This by itself is bad, but when you take into account that Wall Street divided all these loans up into bonds and sold them to investors, you have a perfect storm. When these mortgages fail, the bonds become worthless. When the bonds become worthless, investors start to move into cash or other investments to recoup their losses. However, all investments become overbought, and institutional investors start to sell. Once the big players begin to deal in massive amounts of shares, individual investors will follow, driving prices down even further.
Businesses also invested in these bonds with the thought that people always pay their mortgages. The idea was to make as much money as possible for the company by exploiting people who were being sold a false dream.
So, when we examine AI and wonder if there is a bubble, we need to dig a little deeper into the financial numbers of the companies and pay close attention to how they generate revenue and how they allocate their expenses. We need to ask ourselves if they are generating money from fundraising or revenue, and if their debt is already so large that it will take years to turn a profit. The outlook for the number of data centers required is just another increase in debt purchased through leveraged fundraising. While I hope the talk of a bubble is just talk, I cannot help but feel like this could be a dangerous situation in the near future.
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