How to think about the current AI craze compared to past bubbles

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A version of this story originally appeared on TKer.co

Will AI prove to be a bubble like what we experienced 25 years ago with the Internet boom?

Financial author Phil Rosen asked me for my thoughts on his show, "Full Signal."

I think we should be both optimistic about the future, but also concerned about how things will unfold as we get there.

Whenever you have a game-changing breakthrough in innovation and technology, the excitement over the opportunity will inevitably lead to an overshoot in investment.

As I’ve written for the past two years, I think the potential for AI is massive. Across industries, companies have identified ways to use AI to do things more quickly and often more cheaply. This is the fundamental offering of productivity-enhancing technology: It saves you time and/or money.

People will pay to save time and money. And economics 101 teaches us that where there’s demand, there will be supply.

And that supply is coming with eye-popping amounts of investment, with mountains of cash financing capital expenditures, tons of venture capital flowing into new startups, and lots of savings getting reallocated into the publicly traded companies advancing AI technology.

A lot of those investments will prove lucrative. And a lot will flop.

This behavior is not new. It echoes past technological breakthroughs.

At Berkshire Hathaway’s 2021 annual meeting, Warren Buffett made this observation about the automobile boom of the early 1900s.

"It transformed the country," he said. "There were at least 2,000 companies that entered the auto business because it clearly had this incredible future. And of course, you remember that in 2009, there were three left."

Another example of a formerly white-hot industry is rail transport.

We often talk about how big the tech sector has become as a share of the stock market, drawing parallels to the dot-com bubble. But it doesn’t compare to rail a hundred years ago.

"Markets at the beginning of the 20th century were dominated by railroads, which accounted for 63% of US stock market value and almost 50% in the UK," UBS analysts wrote.

I don’t know too much about the 1800s. However, I understand that there were hundreds of railroad companies financed by those eager to cash in on the buildout of the country’s logistics infrastructure. And the industry’s rise also came with financial crises.

Railroads and automobiles continue to deliver on the promises of saving us time and money. But we wouldn’t have what we have today without overinvestment and a couple of financial blowups.

The big picture 🖼️

As excited as we might be about the stock market returns we’ve realized in the AI boom, it would be a mistake to get complacent.

The emergence of new technology usually comes with volatility in the markets and the economy.

But also, market crashes aren’t guaranteed. And even if we do get what’s deemed an AI-bubble crash, it’ll be close to impossible to time it.

Keep in mind that former Fed Chair Alan Greenspan gave his "irrational exuberance" speech four years before the dot-com bubble peaked. And importantly, the S&P 500 at the post-bubble low was actually higher than where it was when Greenspan gave that speech.

Assuming we do experience a correction related to AI, there’s no way to know the depth and duration before it happens. Maybe it already happened. Maybe there will be multiple bumps in the market’s move higher.

For most investors, the best move is to stay invested through the ups and downs, which can sometimes take years to recover from.

If you’re unable to put in the time and you’re unwilling to stomach the volatility, the stock market may not be for you.