Could Stubborn Inflation Cause the Generative AI Bubble to Finally Burst on Wall Street?

11 May 2024

Inflation has brought a level of uncertainty to Wall Street in 2024 despite a record-breaking Q1 performance for the S&P 500. With much of the growth driving US markets down to the ongoing generative AI boom, could the threat of confounding consumer price index (CPI) data cause the GenAI bubble to burst?

The first quarter saw the S&P 500 cross the 5,000 barrier for the first time as a watershed moment in a sustained rally that coincided with the launch of OpenAI’s ChatGPT generative AI large-language model (LLM).

The index rallied more than 30% since the November 30th 2022 release of ChatGPT towards a peak of over 5,250 before the news of resurgent inflation rates forced a timely reality check.

As news that CPI inflation data for March 2024 came in at a hotter-than-expected 3.5% increase in the same period in 2023, the S&P 500 tumbled back below 5,000 in a 5.46% dip from its peak in late March.

Although US markets have become accustomed to high inflation data, there had been optimism that 2024 would see multiple Federal Reserve rate cuts taking place as inflation cooled. Confounding figures appeared to spark Wall Street to snap out of its long-term rally and address the prospect of higher-for-longer rates.

Looking at one of the generative AI boom’s biggest stocks, Nvidia (NASDAQ:NVDA), we can see that NVDA’s momentum has slowed since March and even posted an 8% dip for the month of April.

Although both the S&P 500 and Nvidia have shown resilience in the wake of the worrying inflation data, analysts remain fearful of what more bad news surrounding inflation estimates could do for undermining the momentum built by generative AI stocks.

Could inflation pressures cause the generative AI bubble to finally burst? Or can we expect more resilience even in the midst of market uncertainty?

Are we in a GenAI Bubble?

According to Bloomberg Professional Services, the generative AI market is set to attain $1.3 trillion in revenue by 2032. However, such lofty expectations could be undermined by signs of a slowdown.

“There's growing evidence that the hype machine is slowing down," notes Gerrit De Vynck, tech reporter at The Washington Post. While many major tech firms like OpenAI, Microsoft, and Google have been busy announcing new projects, the AI hype cycle is so far "yet to upend the way people work and communicate with each other."

In addition to this, we’re yet to see leading firms, aside from hardware manufacturers, begin to access the massive pool of revenue forecasted for generative AI.

According to John Naughton, professor of the public understanding of technology at the Open University, we’re not only in an AI bubble, but we’re already at its third-stage: euphoria.

“Caution has been thrown to the winds and ostensibly rational companies are gambling colossal amounts of money on AI,” Naughton notes in his description of the euphoria stage of the AI bubble.

Naughton surmises that the euphoria stage of the bubble will ultimately give way to profit-taking before reaching its conclusion at the ‘panic’ stage.

Should we find ourselves inside a generative AI bubble, all eyes will be on its most impressive performer, Nvidia for signs of stress.

Kristofer Barrett, equities manager at Swedbank Robur Technology, fears that the runaway success of Nvidia has pushed the firm into retail stock territory as Cathie Wood’s Ark Invest trimmed its exposure to NVDA last year while the share of ESG funds holding the stock fell to 15% at the end of 2023, down from a high of 20% in Q2 2023.

Recent frailties in the S&P 500 off the back of CPI data have come at a time when investors have become accustomed to generative AI hype. For the market to be sustainable, the hype cycle will need to give way to implementation at some level. Whether or not we can reach the implementation stage of the GenAI boom will be down to whether it can deliver on its vast potential.

Reasons to Remain Bullish

Despite fears that the generative AI boom may be a bubble that’s readying to burst, the relative resilience of the S&P 500 which has been sustained by AI stock growth in recent months and leading GenAI stocks like Nvidia can be interpreted as a positive sign of sustainability.

“Concerns about GenAI failing to meet expectations in 2024 should be seen in the context of the natural cycle of hype and maturity of new technologies,” explained Maxim Manturov, head of investment research at Freedom Finance Europe.

“While some industry leaders have expressed frustration with the speed of progress in artificial intelligence and GenAI in their organizations, others remain optimistic about its potential,” Manturov added. “Companies heavily invested in GenAI are under pressure to prove profitability, and industry reports indicate a shift to more strategic AI initiatives in the coming years.”

Nvidia CEO Jen Huang has corroborated the suggestion that AI initiatives are only gathering momentum in the current market.

“Demand is surging worldwide across companies, industries, and nations,” Huang said. “Demand will continue to be stronger than our supply provides through the year, and we’ll do our best [to meet it].”

According to Deloitte tech predictions for 2024, we’re likely to see ‘almost all’ enterprise software companies embed generative AI in at least some of their products this year. As a result, AI chip sales are set to reach more than $50 billion worldwide while software revenue could attain a $10 billion run rate by the end of 2024.

Crucially, Deloitte found that more than 70% of companies are experimenting with generative AI at present, buy less than 20% are willing to spend more money than they already are on the technology.

This data suggests that the pipeline of interest for GenAI solutions isn’t ready to slow down any time soon, and even if there are signs of saturation, falling entry costs would open the market for a far wider range of interested companies.

If there are signs of the generative AI boom slowing, it would more likely take the form of a market correction than a bubble bursting.

Could Inflation Interrupt the GenAI Boom?

Tech stocks are always more vulnerable to difficult inflation data. The 2022 tech stock sell-offs on Wall Street were a timely reminder that more speculative and riskier stocks can struggle as macroeconomic conditions tighten.

This means that confounding inflation data will always have an adverse impact on popular tech stocks, and given the frequency in which CPI inflation is exceeding expectations, investors may have to factor in short-term volatility when building their portfolios.

For investors adopting a more long-term mindset, the prospect of generative AI flourishing into a $1.3 trillion industry will be a key draw. Whether such sky-high predictions can emerge from its hype stage into the implementation stage will be crucial, but for now, the generative AI boom is showing the resilience required for longevity.