AI Bubble? Analyst Warns of Nvidia, Dotcom Crash Echoes

A leading Wall Street analyst has issued a stark warning about the potential for an AI bubble, suggesting that the market's heavy reliance on artificial intelligence infrastructure spending could lead to unsustainable growth. Lisa Shalett, chief investment officer at Morgan Stanley Wealth Management, has drawn parallels between the current market cycle and the dotcom crash, raising concerns about the long-term viability of the tech-driven rally.

Shalett points out that the recent market gains have been disproportionately concentrated in a handful of tech giants and related companies, which account for roughly 75% of the S&P 500’s returns since the latest rally began. This concentration has sparked fears about the market's overall health and the potential for a downturn, especially as economic and competitive pressures continue to mount.

Market Concerns and the Cisco Moment

The current situation has been likened to the 'Cisco moment' of the dotcom era, when the once-dominant networking company's stock plummeted, signaling the bursting of the tech bubble. Shalett estimates that the market is now closer to the 'seventh inning' of its cycle, suggesting that a downturn could occur within the next 24 months. This analogy has heightened concerns about the sustainability of the current market rally, particularly given the central role of companies like Nvidia in driving AI infrastructure investments.

Nvidia's Dominance in the AI Market

Nvidia, with a market cap exceeding $4.5 trillion, has emerged as a key player in the AI market. The company has been heavily involved in scaling up data-center infrastructure, including a $100 billion investment in OpenAI. However, Shalett has expressed concern about 'circular financing,' where Nvidia's cash is essentially being recycled within the AI industry. This practice, she argues, could indicate that the business cycle is nearing its end, raising questions about the long-term sustainability of current market conditions.

Circular Financing and Systemic Risks

The interwoven relationships between major tech companies have further fueled concerns about systemic risk. For example, OpenAI is partially owned by Microsoft, while Nvidia has made significant investments in the company. Additionally, Oracle and AMD have purchasing agreements with OpenAI, creating a complex web of dependencies. OpenAI also has a debt-financed data-center deal with Oracle and has struck a deal with AMD, allowing it to buy up to 10% of the chipmaker. These arrangements, according to Shalett, increase the risk of a market correction if any of these companies face financial difficulties.

Nvidia's Defense of AI Investments

Nvidia CEO Jensen Huang has defended the company's investment in OpenAI, describing it as an 'opportunity to invest' in the future of AI infrastructure. Huang argued that OpenAI will fund the deal through future revenues and capital, depending on investor confidence. He also addressed concerns about circular financing, stating that it is OpenAI's responsibility to determine how they fund their projects and that Nvidia will support their growth.

Bubble Watch: Signs of a Potential Downturn

Shalett's team is closely monitoring the market for signs of a potential bubble burst. One key indicator is the credit default swaps on Oracle debt, which serve as insurance for investors. Rising concerns about Oracle's ability to meet its financial obligations could signal growing unease in the market. Additionally, the fact that the S&P 500 has surged 90% since the October 2022 bear market bottom, with most gains concentrated in a small group of stocks known as the 'Magnificent Seven' and other AI-related companies, has raised red flags about the market's stability.

Concentrated Growth and AI's Economic Impact

The 'Magnificent Seven' companies account for about three-quarters of overall market returns, 80% of earnings growth, and 90% of capital spending growth in the S&P 500. In contrast, the other 493 companies in the index are up only 25%. The economic influence of AI capital expenditures is significant, contributing an estimated 100 basis points to second-quarter GDP growth. However, this concentrated growth has led to concerns about the market's vulnerability to a potential downturn.

Contrasting Views on Nvidia's Investment

While Shalett has raised concerns about Nvidia's investment in OpenAI, other analysts have offered a more optimistic perspective. Bank of America analysts, led by Vivek Arya, have argued that the $100 billion commitment to OpenAI is structured around performance and competitive need, rather than speculative frenzy. Arya noted that Nvidia's entire investment in the AI ecosystem over the past 12 months is less than $8 billion, and he remains bullish on both Nvidia and OpenAI as leaders in the AI landscape.

Market Outlook and Broader Implications

Goldman Sachs CEO David Solomon and Jeff Bezos have also acknowledged the potential for market corrections, noting that not all capital deployed will deliver returns. Bezos characterized the current situation as an 'industrial bubble' that will ultimately pay off in the long run. Meanwhile, Cisco CEO John Chambers has warned of 'irrational exuberance' similar to the internet age, predicting a 'train wreck' for companies unable to translate technology into sustainable revenue. Shalett has further cautioned about media consolidation and 'groupthink' filtering into markets, arguing that a lack of risk premiums could lead to a lack of bearish perspectives.