When the curtain closes on 2024 in less than two weeks, it will likely mark another banner year for Wall Street. The iconic Dow Jones Industrial Average, benchmark S&P 500 and the growth-driven Nasdaq Composite have each soared to multiple record highs this year.
While there has been a confluence of factors pushing Wall Street’s major indexes into uncharted territory, including better-than-expected corporate earnings, stock split euphoria and Donald Trump’s victory in November, nothing is creating more excitement than the revolution on the field of artificial intelligence (AI).
The long-term reachable market for AI is virtually unlimited. Software and systems equipped with AI can become more proficient at their assigned tasks, evolving and “learning” without human intervention. That’s why PwC analysts estimate that AI will add $15.7 trillion to the global economy by the turn of the century.
In response to these generational opportunities, top tier AI stocks have soared – and for good reason.
Nvidia (NASDAQ: NVDA) has gained nearly $2.9 trillion in market value since the start of 2023, with the company’s graphics processing units (GPUs) becoming the undisputed top choice in AI-accelerated data centers. Last week, AI networking solutions specialist Broadcom became only the eleventh listed company in the world to reach a nominal valuation of $1 trillion. Meanwhile, AI-driven data mining specialist Palantir Technologies (NASDAQ:PLTR) is on the heels of a 1,000% gain over the past two years.
These represent just a few of Wall Street’s prominent tech stocks that have soared on expectations that demand for AI hardware and software will change the business landscape.
But while Nvidia and Broadcom’s growth forecasts have knocked even analysts’ highest expectations out of the park, there are reasons to believe the artificial intelligence bubble will burst in the new year.
History has an impeccable track record when it comes to toppling parabolic rallies in next-big-thing innovations
Among the catalysts that could halt the near-parabolic climb of AI stocks like Nvidia and Palantir, none stands out more than history. While history is not a timing tool, it does have an impeccable track record when it comes to predicting any negative consequences among market-leading companies that are on the cutting edge of the next big innovations.
About thirty years ago, the Internet started to go mainstream and changed the growth curve of businesses forever. However, the usefulness of the Internet was not fully understood by businesses for years, which is why we saw the dotcom bubble take shape.
Since the advent of the internet, we have witnessed numerous next-big-thing technologies, innovations and trends, including genome decoding, 3D printing, blockchain technology, cannabis and the metaverse. The problem is that they all suffered an early stage bubble bursting event.
Without a doubt, professional and everyday investors have consistently overestimated how quickly a new technology or innovation would be adopted and used. This ultimately leads to the disappointment that causes market leaders of these next-big-thing trends to lose 80% to 99% of their value.
To be clear, I am in no way suggesting that AI cannot be a breakthrough technology. What I’m saying is that all new technologies and innovations take time to mature. The simple fact that most companies cannot put together a clear plan on how they are going to leverage AI to generate a positive return on their investment is a pretty good indicator that we are in a bubble.
More from The Motley Fool:History says the Nasdaq will rise in 2025. These are the 1 AI stocks to buy right now.
Removing GPU scarcity would stifle investor euphoria (and margins).
Another reason why the AI bubble may burst in 2025 is due to the expected resolution of GPU scarcity that has sent Nvidia stock into the stratosphere.
Demand for Nvidia’s hardware has been otherworldly, with orders for the H100 GPU, commonly known as the “Hopper”, and its successor Blackwell GPU. When demand for a good or service far exceeds supply, it is normal for its price to rise. Earlier this year, Nvidia required about $40,000 for its Hopper chip, which is a whopping 300% premium over what Advanced Micro Devices earned for its Insight MI300X GPUs.
In other words, Nvidia has been able to use the AI GPU shortage to its advantage to increase the price of its hardware and boost its gross margin to the mid-70s.
However, I fully expect this scarcity advantage to diminish in the new year. AMD is rapidly increasing production of its chips and recently introduced its next-generation MI325X GPU.
Additionally, many of Nvidia’s top customers by net revenue are developing AI GPUs in-house for use in their data centers. While Nvidia’s chips should remain superior from a computing perspective, these internally developed GPUs will be significantly cheaper and easily accessible. It’s a recipe for Nvidia to lose valuable data center real estate and see its pricing power and margins decline.
The US government can put the kibosh on the AI rally
Besides the fact that history is not on the side of the AI revolution, the AI rally could also be disrupted by actions by US regulators.
In 2022 and 2023, regulators under the Biden administration announced restrictions on the export of high-performance AI chips and chip-related manufacturing equipment to China. This impacts leading hardware manufacturers such as Nvidia, as well as the equipment the company supplies to produce AI solutions. For example, Lam Research, a semiconductor wafer manufacturing company, generated 37% of its revenue from China during the quarter ended in September, and 39% in the quarter before that.
Under new President Donald Trump, these restrictions are unlikely to be relaxed or lifted. Trump has taken a tough stance on the world’s second-largest economy during his first term as president, and this is likely to continue when he takes office on January 20.
Furthermore, Trump believed he would impose a 35% tariff on US imports from China on day one. More than likely, this will lead to a trade war that will strain trade relations between the world’s two largest economies and negatively impact sales of AI products to China.
PLTR PS Ratio data according to YCharts
AI stock valuations are a thorn in the side that can no longer be ignored
The final reason why the AI bubble will burst in 2025 has to do with historically unsustainable valuation premiums currently awarded to market-leading artificial intelligence stocks.
Over the past thirty years, companies at the forefront of the next big innovations have often achieved revenues more than thirty to forty times greater than the previous twelve months. This is where Amazon and Cisco Systems peaked before the dotcom bubble burst.
In 2024, we have witnessed Nvidia surpass a price-to-sales ratio (P/S ratio) of over 40, while Palantir Technologies is currently targeting a P/S ratio of almost 69. While it is impossible to predict when investor euphoria will fade, history has been crystal clear that expansive valuations of this magnitude are not sustainable in the long term.
While companies with durable moats like Nvidia and Palantir deserve a premium valuation compared to their peers, price-to-sales ratios of 29 for Nvidia and almost 69 for Palantir don’t make sense.
(This story has updated a headline.)
John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Sean Williams has positions at Amazon. The Motley Fool holds positions in and recommends Advanced Micro Devices, Amazon, Cisco Systems, Lam Research, Nvidia, and Palantir Technologies. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
The Motley Fool is a content partner of USA TODAY offering financial news, analysis and commentary designed to help people take back control of their financial lives. Content is produced independently of USA TODAY.
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