- Despite warnings of an AI bubble, some analysts are arguing that AI demand and growth remain strong, with tech sector investment driven by real cash flows, not debt. Current valuations are not as extreme as the dotcom era, and even a correction is unlikely to trigger a U.S. recession, they say.
The S&P 500 hit a new all-time high Wednesday (up 0.58% on the day), driven as usual by tech stocks (the Nasdaq Composite rose 1.12%), despite the fact that both the IMF and the Bank of England warned that AI might be a bubble and stocks are due for a sharp correction.
For weeks, all the talk on Wall Street is that the growth of the AI sector must, surely, be unsustainable and that this bubble is due to pop. The record-high price of gold alone suggests that a lot of investors want a hedge against an implosion in U.S. tech stocks.
Yet some analysts are saying that you should believe the hype. They argue:
- Corporate demand for AI tools is real and growing.
- AI build-out is being funded by hard cash from tech company balance sheets, not risky debt.
- Stock valuations are not as extreme as they were in the dotcom crash of 2000.
- And even if a crash in AI did happen, the fallout wouldn’t tip the U.S. into recession.
The biggest cheerleader for AI is, of course, Dan Ives at Wedbush, who recently published a note titled “Expecting a Robust 3Q Tech Earnings Season to Match the AI Hype; Popcorn Moment.”
“The cloud stalwarts Microsoft, Alphabet, and Amazon had very robust AI enterprise demand in the quarter based on our field checks. While some investors continue to question the valuations and pace of this tech spending trend, we believe to the contrary the Street is still underestimating how big this AI spending trajectory is,” he told clients. He believes these companies will spend $3 trillion on AI over the next three years.
Importantly, that spending isn’t coming from debt or VC funding, according to Jan Frederik Slijkerman and Timothy Rahill at ING. They recently published a note examining whether all this AI spending might hurt corporate credit quality and discovered that … everything is totally fine!
“Investments by the largest technology companies [Amazon, Alphabet, Meta, Microsoft, and Oracle] are expected to surpass the U.S.$400 billion mark in 2026 … The investments described above are mind-blowing, given their scale. What is even more striking is that these investments have been funded from operating cash flows,” they wrote.
“From a debtholder perspective, we are less concerned with a potential mismatch between supply and demand, as the large technology platforms mentioned above have funded their expansion plans from their cash flows,” they said.
Goldman Sachs agrees, in part for the same reasons. The bank published a note yesterday titled “Why we are not in a bubble … yet,” which pretty much says it all.
Still, surely stocks are overvalued? The majority of gains in the S&P 500 this year have been driven by a handful of tech companies. That concentration risk could hurt investors if there is a pullback.
We aren’t there yet, according to Jeff Buchbinder, chief equity strategist for LPL Financial in Boston. “The forward price-to-earnings ratio (P/E) of the S&P 500 has yet to reach dotcom era levels, and in fact remains below December 2020 levels because earnings were depressed coming out of the COVID-19 pandemic,” he said in a note today. “So large-cap stocks are expensive, lifted by AI-driven technology stocks, but not quite to the extremes of 25 years ago.”
The economics of AI are much more robust than the dotcom era, he says. “Perhaps the key difference between the broader secular AI growth theme and the dotcom era is that large AI hyperscalers have mostly funded capital expenditures (capex) with strong internal cash flows, not through AI revenue in singularity or by issuing debt or equity. In comparison, dotcom era spending was broadly funded through massive amounts of ‘vendor financing,’ which ultimately led to the circular flow of capital that fueled the bubble burst.”
And even if there is a correction, it won’t be too bad, argue Samuel Tombs and Oliver Allen at Pantheon Macroeconomics. They estimate that AI capex boosted U.S. GDP growth by 0.3% points. Even if it all disappeared it would not be enough to tip the U.S. into recession, they say. “Weaker growth is more likely than a recession if the AI boom turns to bust,” they said in a note to clients. “The likely hit from the AI boom turning to bust would be a significant drag on the economy, but probably a smaller shock than the bursting of the dotcom bubble in 2000, and an ensuing recession would be far from a forgone conclusion.”
That comes with a caveat: “It would be more alarming, though, if a reversal of AI optimism led to a broader correction in the stock market beyond AI-linked companies, especially if the hit to households’ wealth and confidence tipped the fragile balance in the labor market, leading to a jump in the layoff rate,” they said.
Here’s a snapshot of the markets ahead of the opening bell in New York this morning:
- S&P 500 futures were flat this morning. The index closed up 0.58% in its last session.
- The STOXX Europe 600 was down 0.22% in early trading.
- The U.K.’s FTSE 100 was down 0.21% in early trading.
- Japan’s Nikkei 225 was up 1.77%.
- China’s CSI 300 was up 1.48%.
- The South Korea KOSPI was up 2.7%.
- India’s Nifty 50 was up 0.54% before the end of the session.
- Bitcoin fell to $121.4K.
