The AI Trade Is Under Assault
This summer has seen a slew of reports suggesting the AI trade is a bubble. If it is, and it bursts, what remains of the economy and the stock market?
The AI trade has been coming under question the past couple of weeks. Most recently, there have been downgrades to stocks based upon what analysts believe will be shortcomings on what is being spent versus what will be gained with companies in their AI projects.
First, we associate Nvidia with the AI trade because this company outperforms all others as a chip manufacturer. Nvidia does a few other things that add significantly to its bottom line. But if we start to see continued downgrades in the AI landscape, NVDA’s multiple may come into question.
For now, I see Nvidia being solidly priced relative to other stocks and in consideration to its growth prospects. But if companies fail to produce results based upon their respective AI investments, Nvidia’s growth potential will falter, and NVDA stock could get rocked.
That being said, NVDA stock is still relatively high, and there is always move upside potential, all else equals.
Given that, however, NVDA could become a victim of guilt by association; it is the other stocks that are likely to pull NVDA down, as reality catches up to the bubble of other companies.
There are, however, other considerations that need to be taken. In totality, the AI trade could fall apart from multiple factors to include individual companies falling short, and the US economy itself.
Understanding The Law of Relativity
This is the US 10-Year Treasury yield. This is the measuring stick upon which all other investments are compared. The 10-year is offering 4.15% as of right now. If you were to lend the US government, say, $10,000.00 for 10 years, they would pay you $415.00 per year (Notes are paid 2x per year).
Relatively speaking, the US government is a safe investment. We hope that remains a constant, notwithstanding major shifts in the government as well as a looming shutdown at the time of this writing. As an investor, the relative safety of lending money to the government is considered risk-free, and guaranteed. But investors have other options.
If you wished to invest in another opportunity, there will likely be higher risks accompanying that. Because of these elevated risks, any investment would likely have an increased return on investment given the higher risk parameters.
NVDA Multiples
Above is a long-term look at the P/E ratio of the S&P 500. Anyone wondering if the stock market is in a bubble, this is a good first stop. While the P/E ratio is elevated, it is not near its all-time highs.
The P/E ratio is currently at 28.68 of forward earnings. What this means is that when you add up the next four quarters of projected earnings for all of the stocks on the S&P 500, and the price of all of these stocks is 28.68 of the forward earnings.
Right now, NVDA is trading at $181.00. Projected earnings per share for the next four quarters from Nvidia are: $1.58, $1.50, $1.42, and $1.24, which adds up to $5.74 in total earnings per share expectations. NVDA stock, at $181.00, is 31.5x forward earnings. This is actually fairly reasonable considering the pace of growth Nvidia is currently experiencing.
But, this is just NVDA stock. Nvidia makes the infrastructure that other companies are building up their services. This is where the problem lays, and this is what could wobble NVDA and the remainder of the AI trade.
All The Other AI Stocks
According to ChatGPT, here is a breakdown of the Top 20 AI-Exposed companies:
Semiconductors & Hardware
Nvidia
Advanced Micro Devices
Intel
Broadcom
Micron Technologies
Cloud & AI Platforms
Microsoft
Alphabet
Amazon
Oracle
IBM
Software & AI Integration
Salesforce
Adobe
Palantir
Service Now
Snowflake
AI-Driven Applications & Vertical Leaders
Tesla
Meta Platforms
Apple
Baidu
Tencent
The key takeaways are that the chipmakers are the picks-and-shovels for AI, but cloud platforms will be the dominant AI-as-a-service.
Many of these companies have high forward P/E ratios as well as the aforementioned NVDA. But what we have not seen is an overwhelming return on the spend. However, the returns for all of these companies have not been as equal. While there are notable mentions; Microsoft, Alphabet, Amazon, Palantir, and Meta, other companies are getting downgraded for failing to hit their marks.
If the returns don’t show up, investors may start to get anxious, then hit the sell button. There may be a bottom move that starts with the minor players first, then capture the bigger players. The catalyst for this may come from more than one direction.
Scaling Back
First, it boils down to a return on investment. Reports have shown that nearly none of the secondary, AI-as-a-service companies have cleared profitability despite massive investments. On the one hand, not investing would leave any respective company in the dust. But to invest, and not see commensurate returns may be just as bad.
What I can see with some companies is that they begin to scale scale back on their individual investments. While there has been a bubble-esque arms race to get products & services available for consumers, a lion’s share level has been reached. This calls into question Nvidia’s growth rates and returns. If that wobbles, they all fall.
Economic Downslide
Second, the economy itself is starting to feel the strains of obstructive policies. The tariffs are weighing on employment gains and corporate revenues. This will begin to weigh on the overall broader stock market.
With employment growth narrowing, this weights on overall equity market valuation. While the Federal Reserve has started to lower interest rates, this will not overcompensate for the extreme price increases the tariffs have caused.
Yet, the stock market continues to meander higher and higher.
Conclusion: Be Wary, Very Wary
The Federal Reserve has begun to move. I don’t see government data showing that price pressures will push too far, too fast. The is purely an American issue, and the rest of the world is not experience any real inflation growth that is the same. So far, this is how it is playing out. Eventually, with the Supreme Court removing the tariffs, immediately, price pressures will drop. Then, any moves that the Federal Reserve have done will, will work on economic growth. Removing the tariffs will alleviate consumer declines, and there will be upside growth prospects from there.
In the meantime, the AI trade may continue to be assaulted. I see a potential of more analysts reports being released that calls out revenue potential in the secondary companies pursuing AI investment and business. These companies may begin to scale back their investments as they have not been profitable. This, then, will start to rattle Nvidia’s upside as they see investment in AI start to wane.
This will be something I look at more and more over the following 3-6 months as this plays out.