AI: A Ticking Time Bomb? Can AI Stocks Avoid a Dot-Com Crash?

We live in an era where artificial intelligence is transforming the way we interact with technology, giving rise to innovations that were once considered science fiction. Just as the advent of the internet revolutionized our world in the late 20th century, AI is now transforming industries and daily life at an unprecedented speed.

Today, businesses are leveraging AI in a wide range of applications. In cloud computing, AI improves data management and security. Office software integrates AI to streamline workflows and improve productivity.

The automotive industry is using AI in electric vehicles to advance autonomous driving and optimize performance. E-commerce platforms are using AI to personalize shopping experiences and improve customer service. Search engines are using AI to refine search algorithms and deliver more accurate results.

Experts are talking about a new industrial revolution that will change the way we live. Big tech companies are investing billions in AI infrastructure, preparing for this transformative change.

Tech rally fuels market rally

The rise in the US stock market this year has so far been mainly due driven by a strong rise in technology stocksfueled by speculation that big tech companies will benefit from advances in artificial intelligence.

This surge has added trillions of dollars to the market valuations of these companies. Companies such as Nvidia, AMD, and Broadcom have seen substantial growth due to increased demand for chips and AI solutions. Nvidia, in particular, has consolidated its dominance in the GPU market, which is critical for AI components, and now holds a significant market share.

Nvidia’s stock price has surged 120% since the start of the year, propelling Nvidia into the $3 trillion market cap club alongside Apple and Microsoft. Nvidia’s rise has been the fastest among tech giants, hitting the $3 trillion mark in a record 96 calendar days.

Other technology stocks have also followed the rally, pushing the S&P 500, the main U.S. index, to record highs 36 times this year.

Too far, too fast

Investor optimism about AI’s potential has propelled tech stocks to lofty levels, creating an environment where strong earnings were needed to support these valuations. As June quarter results were released, investors eagerly looked for signs of when the hype and massive capital investment in AI would translate into financial gains.

However, the results of the big technology companies have been disappointing, failing to meet investors’ high expectations. This mismatch between expected and actual performance has triggered a wave of selling.

The recent earnings season highlighted the challenges these companies face in converting AI advances into immediate financial returns, prompting a reassessment of stock valuations and a subsequent market pullback.

Disappointing results

Amazon reported lower-than-expected net revenue for the June quarter, raising concerns among investors about the big investments in artificial intelligence that these companies are making.

The e-commerce giant also issued third-quarter net sales guidance that fell short of consensus expectations. That disappointing outlook contributed to a 9% drop in Amazon’s stock price on Friday, closing at $167.90.

Tesla shares have fallen 15.5% since reporting its second-quarter results on July 23. The report revealed another quarter of disappointing earnings, largely due to the impact of electric vehicle (EV) rebates on the company’s profit margins. These rebates led to a decline in the average selling price.

Competition has intensified, particularly in China. In response to falling sales this year, Tesla has slashed prices on its popular electric vehicle models and introduced other incentives, such as low-interest loans.

Additionally, the company’s decision to delay the unveiling of its Robotaxi from August to October further dampened investor sentiment.

Shares of Alphabet, Google’s parent company, also fell after reporting June quarter results. Despite beating expectations for profit and revenue, YouTube’s ad revenue fell short of consensus estimates.

Similarly, Microsoft shares fell after its second-quarter results, despite beating expectations for both revenue and earnings. The focus was on weak cloud performance, although executives were optimistic, predicting a faster growth rate for the cloud segment in the first half of 2025.

Worst intraday drop in 40 years

Shares of Intel Corp fell 26% in Friday trading, the biggest intraday drop in more than 40 years after the company gave a gloomy growth forecast and outlined plans to cut 15,000 jobs to cut costs.

The company is facing significant financial losses, with a loss of $1.6 billion in the second quarter and $437 million in the first quarter, according to recent reports.

The main problem comes from its manufacturing business, where the company makes chips. Unlike Nvidia, which focuses solely on designing advanced AI chips, the production of these chips is outsourced to companies in countries like Japan, South Korea, or Taiwan. This outsourcing model allows Nvidia to avoid the high costs associated with chip manufacturing.

Recession fears grow

In addition to disappointing earnings reports, concerns about a Potential recession has hampered tech stocks’ recoveryThe S&P 500 and Nasdaq saw significant declines on Friday after new data showed signs of weakness in the U.S. economy.

July data showed that manufacturing activity contracted at its fastest pace since December 2023 and employment growth slowed significantly. In addition, the unemployment rate unexpectedly rose to 4.3%, its highest level since October 2021.

Following the July jobs report, many Economists have criticized the Federal Reserve for keeping interest rates high for an extended periodThey argue that the Fed should have cut rates last week to support the economy, as labor market data shows signs of weakening.

On July 31, the Fed kept interest rates unchanged at a 23-year high of 5.25% to 5.50% for the eighth consecutive meeting in July 2024, in line with expectations. The Fed has been holding these rates for over a year now. However, Jerome Powell has indicated that a rate cut could come as early as September.

Economists have pointed out that even if the Fed cuts rates in September, current high rates have already made it more expensive to borrow money to buy homes, cars or use credit cards. Moreover, it could take several months or even a year for the full effects of a rate cut to be felt in the economy.

Bubble or breakthrough?

When stock prices rise rapidly over a short period of time, it often indicates excessive speculation and a race among investors to capitalize on the perceived opportunity. This type of explosive growth can create an unsustainable bubble, where prices reach levels far above their intrinsic value.

As history has shown, these bubbles eventually burst, leading to major stock market corrections. It is worth noting that these giants in their respective fields have significantly outperformed small-cap stocks.

For example, Nvidia shares have surged 745% since January 2023, while Meta Platforms, Amazon, and Alphabet have seen gains of 305%, 117%, and 106%, respectively. It’s worth noting that these gains have remained substantial even after the recent selloffs.

The current rise in tech stocks follows a similar pattern to the dot-com bubble of the late 1990s, a time when the rapid rise in prices of internet-related stocks led to an overvaluation of the entire tech sector. The dot-com bubble burst in March 2000, causing the S&P 500 to drop 49% by October 2002.

The dot-com bubble followed Gartner’s hype cycle, where initial enthusiasm for the internet led to inflated expectations and excessive valuations in the technology sector. When the bubble burst, the market crashed and many analysts doubted the future of the internet. However, practical applications such as e-commerce and cloud computing quickly emerged, proving the internet’s crucial role in the global economy.

Artificial intelligence could follow a similar trajectory. Gartner estimated in 2023 that generative AI was nearing the peak of inflated expectations and could reach a more stable phase within two to five years. While AI stocks could see a slowdown and potential decline, current valuations suggest any decline would likely be less severe than the dot-com crash.

Disclaimer: The opinions and recommendations expressed in this article are those of individual analysts. They do not represent the views of Mint. We advise investors to consult certified experts before making any investment decisions.