The froth is finally coming off the cappuccino. After months of irrational exuberance, the artificial intelligence stock market bubble looks set to pop, leaving investors nursing a nasty hangover from too much speculative caffeine. The tech-heavy Nasdaq Composite has shed 8% in the last fortnight, and the rot is spreading to the broader market. This is not a correction. This is the beginning of a repricing, and it is long overdue.
For months, I have watched with growing alarm as retail investors piled into any stock with 'AI' in its name. Companies that have never turned a profit have been valued as if they were the second coming of Microsoft. But the market is finally sobering up. The catalyst? A barrage of disappointing earnings from the very darlings of the AI boom. Take C3.ai, a firm that has somehow managed to lose money every quarter since its IPO, yet saw its stock triple in 2023. Its latest results missed already-lowered expectations, and the shares have halved in a week. Or consider Palantir, which trades at a price-to-sales multiple of 20, despite slowing growth. The market is finally asking the question that should have been asked months ago: where are the profits?
The truth is that AI hype has far outstripped commercial reality. Yes, generative AI is a transformative technology. But transforming a balance sheet from red to black takes years, not quarters. The capital expenditure required to build and train these models is enormous, and the returns are uncertain. As one hedge fund manager told me, 'It's like the dot-com era all over again, except this time the promise is even bigger and the losses even deeper.'
The central banks are not helping. The Federal Reserve's insistence on keeping rates high to combat inflation is squeezing the life out of speculative tech. Higher discount rates reduce the present value of future earnings, and for AI firms whose earnings are a distant mirage, the arithmetic is brutal. Capital is becoming scarce, and without easy money, the unicorns are turning back into donkeys.
Meanwhile, gilt yields are rising on both sides of the Atlantic, as investors demand a premium for holding government debt. The yield on the 10-year US Treasury has surged to 4.7%, making risk-free returns increasingly attractive compared to the casino of AI stocks. Capital flight from equities to bonds is accelerating, and the sell-off is becoming self-reinforcing.
One need only look at the recent action in the options market to see the panic. Put volume on tech stocks has exploded, with traders betting on further declines. The VIX, Wall Street's fear gauge, has spiked above 25 for the first time since October. This is not the behaviour of a market that is merely 'taking a breather'. This is a rout.
Fiscal responsibility has been thrown out of the window as governments throw subsidies at AI projects. But the taxpayer will eventually have to foot the bill when the bubble bursts. The resurrection of industrial policy may be fashionable, but it rarely ends well. When the state picks winners, it usually ends up backing losers.
What should investors do? The old adage applies: be fearful when others are greedy. If you own AI stocks, consider taking some profits. If you are tempted to buy the dip, remember that catching a falling knife is a bloody business. Cash is a perfectly respectable asset class. So are inflation-linked gilts, which at least offer some protection against the persistent inflation that shows no sign of abating.
The AI bubble is not yet fully deflated. There will be further falls. The technology may indeed change the world, but the stock market is not the world. It is a discounting mechanism, and it is finally starting to price in the unglamorous truth that most AI companies will never make a profit. The party is over. It is time to pay the bill.
