With more than 30 years on Wall Street, Jim Covello, head of equity research at Goldman Sachs Group Inc., knows how painful it is to short an expanding bubble and that the market always has a way of rising month after month.
That happened in the dot-com bubble of the late 1990s and more recently in the cryptocurrency space. The Goldman Sachs Group Inc. head of equity research said the same is likely to happen with artificial intelligence, but it could be dangerous, or even foolish, to start shorting companies like Nvidia (NVDA) now.
Yet Covello has no doubt that the Great Reckoning is coming. It may not come this year, or even next year, he says, but it will happen someday. In his view, the tens of billions of dollars that companies are pouring into artificial intelligence will not spark the next economic revolution, or even compare to the benefits of smartphones and the internet. When that becomes clear, all the stocks that have soared on this narrative will also slide. Covello said:
“Most technological transitions in history, especially transformative ones, have seen us replace very expensive solutions with very cheap ones, but now we are replacing jobs with extremely expensive technology, which is basically the exact opposite of history.”
Covello is becoming the leader of a small but growing group of market watchers who are questioning a key thesis underpinning the S&P 500’s (SPX) rally since late 2022: that the incredible power of large language models will usher in the world’s next “industrial revolution,” in which corporate profits soar as more work is handed over to intelligent machines, boosting efficiency and accelerating growth.
Many on Wall Street think it's possible. JPMorgan Chase CEO Jamie Dimon has said he is convinced that AI will bring about extraordinary changes, perhaps as transformative as those brought about by printing, steam engines and electricity. Michael Arone, chief investment strategist at State Street Global Advisors, said AI has brought about a "lasting and unprecedented productivity miracle." Even within Covello's own company, Joseph Briggs, senior global economist at Goldman Sachs, estimates that AI will eventually automate a quarter of all work tasks and boost the pace of economic growth.
The speculation has sparked a tangible boom, with the world’s largest technology companies investing heavily in a bid to extend their dominance into the latest frontiers. That’s good news for companies like Nvidia, Broadcom and Advanced Micro Devices that provide the hardware that powers artificial intelligence models. Even utilities are seeing a surge in sales as the industry’s demand for data centers, which have huge electricity needs, surges.
The problem, however, is that commercial expectations for the technology may be wildly overestimated, skeptics say, creating the risk of a stock market pullback if tech giants rethink their investments.
Don't be the last fool
David Bahnsen, founder and chief investment officer of Bahnsen Group, has been preparing for this scenario and has been avoiding Nvidia and other large-cap tech stocks because he expects a potential "disaster." He said:
"The way we made money was by not holding Cisco stock after the last sucker bought it in March 2000. Cisco's stock price fell dramatically after the dot-com bubble burst. If you don't sell those shares early, you will lose a lot of money."
So far, though, there are few signs that will happen. While technology stocks fell on Wednesday on concerns that chipmakers will be drawn deeper into a trade war, they still hold near all-time highs.
Nearly half of the S&P 500's gains since bottoming in October 2022 have been concentrated in just six stocks: Apple (AAPL), Microsoft (MSFT), Nvidia, Alphabet (GOOGL), Amazon (AMZN), and Meta (META).
Nvidia has added nearly $2 trillion to its market value this year and remains one of Wall Street's most popular stocks. Of the 64 analysts covering the chipmaker, 64 still recommend clients buy the stock, even as it has risen nearly 140% this year. Only one recommends selling.
Despite these companies’ large investments in AI, however, the returns have so far been relatively small.
Microsoft, Alphabet, Amazon, and Meta have collectively invested more than $150 billion in capital expenditures over the past four quarters, much of it on computing power to train their own large language models and serve their customers.
Microsoft, which has been integrating OpenAI’s technology into its product lines, said in April that AI contributed 7 percentage points to a 31% increase in sales of Azure and other cloud services in the third quarter, but did not give a dollar amount.
Amazon, which expects to generate more than $600 billion in sales this year, says only that its AI business is “already multi-billion dollar in revenue.” During Alphabet’s first-quarter earnings call, CFO Ruth Porat acknowledged that “AI is an increasing contributor to Google Cloud revenue.”
For some, like Adam Gold, chief investment officer at Katam Hill, who remains heavily invested in Nvidia, it’s too early to focus on certain numbers, noting that companies like Meta, which doesn’t charge users directly, have achieved sales growth by using artificial intelligence to improve ad delivery and user engagement.
For some of the cloud computing giant's customers, the benefits aren't obvious. Less than half of companies investing in artificial intelligence have yet to see significant returns, according to a survey conducted by San Francisco-based Lucidworks.
Covello doubts most companies will ever see a payoff. He has covered the tech sector since joining Goldman Sachs in 2000, winning awards year after year as the industry’s top analyst before being promoted to head of U.S. equity research at Goldman in 2015.
He expects investments in AI infrastructure to reach about $1 trillion over the next few years, but to reap sufficient returns, AI must be able to help companies solve increasingly complex tasks.
In his view, AI has shown the potential to make some jobs, such as programming, more efficient, but not nearly enough to justify its cost.
He said that if significant usage doesn’t start to emerge in the next year and a half, the stock market will reverse. However, he believes that the AI narrative has not yet reached that stage and will likely continue to drive investors into stocks like Nvidia. He said:
“One of the most important lessons I’ve learned over the past 30 years is that bubbles can take a long time to burst.”
Article forwarded from: Jinshi Data