AI Is Creating a Moment of Extreme Risk

Editor's note: According to our colleague Dan Ferris, the artificial-intelligence mania isn't playing out as predicted. Yesterday, he covered one sign of trouble ahead for the sector. Today, we're concluding his two-part series, adapted from his most recent Stansberry Digest. As we'll see, if Dan is right about this overheated trend, the stock market might be in for a reckoning down the road...

Billions of dollars continue to pour into artificial intelligence ("AI")...

The Wall Street Journal reports that Amazon, Alphabet, Microsoft, and Meta Platforms have already spent a few hundred billion dollars on AI, including more than $52 billion in the second quarter of this year.

The four have reported roughly $598 billion in total capital spending since 2020.

Meanwhile, OpenAI just received more than $10 billion in new financing, putting the firm at a $157 billion valuation. That's up from $29 billion in 2023 and $80 billion earlier this year.

The company raised $6.6 billion from a list of big companies and opened a $4 billion line of credit, with an option to increase it by $2 billion.

It'll have no trouble burning through all that cash.

OpenAI expects to lose $5 billion in 2024 on expected revenues of $3.7 billion. Though nowhere near profitable, monthly revenue hit $300 million in August, up 1,700% since the beginning of 2023. The company is forecasting $11.6 billion in revenue next year... and $100 billion by 2029.

Nobody is making money on AI yet...

Companies are just spending and logging operating losses, hoping to come up with a great business one day. Money is pouring in from investors... and yet there's nothing but operating losses as far as the eye can see.

We've seen this kind of thing before. And the massive investment in this technology signals that the market may be approaching a high-risk moment...

Yesterday, I covered economist Daron Acemoglu's three visions of how AI could play out economically and financially. With the capital spending arms race heating up, let's agree that the first scenario – in which AI interest slowly cools – is off the table.

So will we instead see the second scenario, where tech stocks crash and investors move on to their next ill-fated fad?

Or will this nonsense go on for years and years... and eventually end up in the worst-case scenario: a massive global rout where everybody realizes they're never going to make any money at it?

Consider the incredible cash-gushing power of companies like Nvidia, Microsoft, Alphabet, and Meta... their cash-rich balance sheets... and their mindless devotion to technology.

It's not hard to see this third scenario playing out, ending in – as Bloomberg recently put it – "widespread negative outcomes for the whole economy."

Remember, the market has a way of delivering the worst pain to the greatest number of people.

The age of "massive prosperity" that OpenAI CEO Sam Altman predicts sounds disturbingly like the "new era" declarations that have accompanied every major market top... ever since Irving Fisher declared that stocks had reached "what looks like a permanently high plateau" on October 15, 1929.

At the time of Fisher's remark, the Dow Jones Industrial Average was trading about 9% below its September 3 peak – a level which wouldn't be eclipsed for 25 years – and was just two weeks from the massive crash of October 28 to 29, when it would lose nearly 24% of its value in just two trading sessions.

Now, I know I sound bearish (as usual).

But I can't go full-on bearish because of one development...

The Federal Reserve, European Central Bank, and People's Bank of China have all cut interest rates. The Bank of Japan has also signaled a pause to its promised rate hikes. Yet asset prices are soaring. At a time like this, these moves are unprecedented...

Investors are already optimistic, buying the most expensive stock market in history. Easier financial conditions could wind up throwing gasoline on the proverbial fire.

In other words, the world's central banks may have just set off another dot-com-bubble-like episode.

That could mean a boom, at least in the short term. During the dot-com bubble, the Nasdaq Composite Index rose 255% from October 1998 to March 2000.

The dot-com bubble was the most expensive moment in history by our favorite metric, the S&P 500 cyclically adjusted price-to-earnings ("CAPE") ratio. The CAPE ratio hit 44 in December 1999 – three months before the index fell 49% during a 21-month bear market. The Nasdaq fell 78% over the same period and took 15 years to recover.

There's always a horrendous reckoning on the other side of a massive mania.

Today, the CAPE ratio is 37. That's its highest level since December 2021... shortly before the start of a 10-month 25% rout in the S&P 500.

I'm not making any predictions. I'm not saying AI has no value whatsoever and doesn't deserve any investment capital. And I'm not calling the top. Nobody can predict market tops.

But as I've repeatedly pointed out, you can absolutely identify moments of extreme risk.

That's what this is. The fact that the world's central banks might have set off a global frenzy that could send the world's stock markets soaring is not a good thing.

Risk and markets travel in the same direction. And the higher they go and the bigger the valuations get, the harder they tend to fall.

Be careful out there... especially when it comes to investing in AI.

Good investing,

Dan Ferris

Editor's note: Dan says it's only a matter of time before the market's tech darlings turn into a financial nightmare. It could be a disaster for AI investors who don't realize what's happening. That's why you need to be ready for the "next big trade" – a small group of stocks that could be the difference between suffering huge losses and enjoying the retirement you've envisioned... Get the full story here.