Senior Strategist: The Burst of the AI Bubble Will Come Before the Popularization of AI

Ian Harnett, co-founder and chief investment strategist of Absolute Strategy Research, warned in a post that the AI bubble is nearing its end.

Harnett believes that the current surge in AI stocks and the frequent trading within the industry have shown typical bubble characteristics, and the recent dramatic increase in capital expenditures (Capex) by tech giants is the final key piece of this bubble reaching its peak.

Harnett also stated that the current AI craze is astonishingly similar to the internet technology, media, and telecommunications (TMT) bubble of the late 1990s. History shows that the bursting of such bubbles is not due to the illusion of technological dreams; on the contrary, it is driven by over-investment. This collapse will ultimately pave the way for the true popularization of AI technology through a process of "creative destruction," but at the cost of significant losses for late-stage investors who foot the bill for this feast.

Echoes of History: Capital Expenditures Sound the Alarm for the End of the Bubble

Harnett believes that for some time, AI stocks have possessed all the elements of a bubble: soaring stock prices leading to excessive concentration in U.S. stock indices; AI companies boosting each other's valuations and growth through mutual investments and product purchases. Recently, the last key element—the rapid expansion of physical capital—has also fallen into place. Global "hyperscalers" are investing in AI infrastructure at an unprecedented scale, perfectly replicating the capital expenditure frenzy on the eve of the TMT bubble's collapse.

Looking back at history, whether it be railroads, electricity, or the internet, almost all general technologies have been accompanied by bubbles. The end of these bubbles was not due to disillusionment with new technologies, but rather because of tightened regulations, intensified competition, or the inability or unwillingness of product buyers to continue paying for them.

Harnett believes that AI is facing the same vulnerabilities: Europe's Artificial Intelligence Act represents the arrival of regulation; lower power consumption models from countries around the world are intensifying competition; more importantly, the cash flow of tech companies is beginning to come under pressure.

While technology themes may be structural, their end users are cyclical. Once the ultimate buyers of AI face external cash flow shocks, this carousel of capital will come to a swift halt. At that time, the speed of revenue collapse will far exceed the speed of capital expenditure cuts, leading to a sharp decline in corporate profits and accelerated depletion of cash reserves. This is a fatal warning for investors.

The lessons of the TMT bubble are vivid: in the aftermath of the crash in 2000, even the eventual winners were not spared, with Microsoft’s stock price dropping 65%, Apple down 80%, Oracle down 88%, and Amazon plummeting 94%. These companies took 16 years, 5 years, 14 years, and 7 years, respectively, to return to their previous highs

Creative Destruction: Who is "Selflessly" Paying for the Future of AI?

At the same time, Harnett also believes that bubbles are not entirely destructive.

He further explains that, as scholar William Janeway points out in his writings, bubbles, especially the excessive capital expenditures they generate, are a core element in the popularization of new technologies. The frenzied hype surrounding new technologies significantly lowers the cost of capital, providing massive funding for rapid infrastructure development.

When the bubble bursts, the excess capacity built by exorbitant investments does not disappear. It can be acquired by new participants at very low prices, which is precisely what economist Joseph Schumpeter described as "creative destruction"—it allows new technologies to be utilized by society at costs far below those during prosperous times, ultimately embedding technology deeply into the economic system.

For investors, this means a harsh reality: those equity investors who funded excessive capital expenditures in the late bubble phase are very likely to lose most of their investments. To survive a collapse of 70% to 80%, investors needed to enter the market as early as 2019-2020.

Harnett also mentioned that the good news is that this round of AI capital expenditures is primarily funded by equity rather than debt, which means that its collapse may have a more similar impact on the overall economy to the TMT crisis, rather than the systemic financial crisis triggered by debt in 2008. Policy responses should also draw lessons from the experiences of 1987 or 1998, rather than the zero interest rates and quantitative easing following the global financial crisis.

In summary, aggressive AI capital expenditures almost guarantee that AI technology will be ubiquitous in the future. But the bad news is that the arrival of that day is likely to be predicated on a severe "creative destruction."

Therefore, Harnett warns that for those investors buying AI stocks at high valuations such as 30 times earnings or 8 times sales, it may be worth asking themselves: unless you are willing to play the role of an altruist, sacrificing personal capital to fund this long-term societal transformation, "be very cautious."

Risk Warning and Disclaimer

The market has risks, and investment requires caution. This article does not constitute personal investment advice and does not take into account the specific investment goals, financial situation, or needs of individual users. Users should consider whether any opinions, views, or conclusions in this article are suitable for their specific circumstances. Investing based on this is at your own risk