🧠 Is Generative AI Overhyped?

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Welcome back AI prodigies!

In today’s Sunday Special:

• 🧊ChatGPT Chills

• 📊Markets Rip, Bubble Unlikely

• 🧨Private Market Woes

• 🔑Key Takeaway

Read Time: 6 minutes

🎓Key Terms

• Federal Funds Rate: the target interest rate range the Federal Open Market Committee (FOMC) sets. At this rate, commercial banks borrow and lend their excess reserves to each other overnight. Lower interest rates allow companies to borrow cheaply and grow faster.

• Forward Price-To-Earnings (P/E) Ratio: a company’s stock price compared to its future profits. Higher values indicate a company may be overvalued.

• Financial Leverage: trading or investing with borrowed money, which increases stock market volatility.

🩺 PULSE CHECK

🧊CHATGPT CHILLS

OpenAI’s ChatGPT launched on November 30, 2022. It attracted over one million curious users within five days and 100 million signups within a few months. ChatGPT’s user growth has plateaued today, at least from a consumer perspective. OpenAI doesn’t publish up-to-date figures, but Google Search trends are a proxy for consumer interest. Google Search interest for “ChatGPT” is down 10% from its peak in April last year. Most Americans hadn’t heard of it then, and just 14% had submitted a query. ChatGPT was the first generative AI tool to pierce mainstream American culture and is today’s second-best conversational chatbot. Its plateau may be a bellwether for the consumer generative AI space, but the product still garners tremendous interest. Below, we’ve provided some context:

• ChatGPT: 1.63 billion visits and 180 million total users in February 2024.

• Google Search: 163 billion visits and 4.9 billion total users in February 2024.

Google Search may have generated 24 more visits per signup than ChatGPT, but it’s the default search engine in major browsers and boasts unparalleled name recognition and vast geographic reach. Within just 16 months in consumers’ hands, ChatGPT’s usage is thoroughly impressive. Nevertheless, its plateau comes at a time when AI hype may exceed reality.

📊MARKETS RIP, BUBBLE UNLIKELY

Some stock market analysts question the durability of the recent AI-driven rally. In the 16 months since ChatGPT’s launch, the Nasdaq, an index of the largest public technology companies, is up more than 50%. Though expectations of a lower Federal Funds rate have fueled part of the rally, observers cannot ignore lofty AI expectations, as they drove the prices of the so-called Magnificent 7—Apple, Alphabet, Amazon, Meta, Microsoft, Nvidia, and Tesla—up a mouth-watering 106% in 2023. Since the Nasdaq’s inception in 1984, such rapid appreciation has only occurred twice, and both rallies created bubbles. In 2000, speculators poured money into unprofitable internet startups. And in 2021, on post-pandemic economic recovery hopes, unprecedented money printing, and bottomless government spending, investors got ahead of themselves.

This time may be different. At the beginning of this year, the S&P 500 had a forward price-to-earnings (P/E) ratio of about 15.5X, excluding the Magnificent 7. In contrast, the Magnificent 7 has a forward P/E ratio of about 35X, according to Capital Group. At first glance, this seems problematic; investors are willing to pay almost double to own the stock of big technology companies rather than other large corporations. However, investors expect Magnificent 7 to produce profit growth nearly triple that of non-Magnificent 7 companies. Diving deeper, an “AI bubble” is likely not underway. AI-powered stocks’ valuations are still intact, and the current financial leverage level isn’t sufficient to cause concern. But in the words of Karl Marx, “history repeats itself, first as a tragedy, second as a farce.” Marx’s wisdom extends to capitalism. Greed isn’t going anywhere. And a bubble isn’t a bubble until it bursts. However, aside from some highly overvalued AI companies outside the Magnificent 7, like C3.AI, which ironically trades under the ticker $AI, AI has yet to create a stock market bubble.

🧨PRIVATE MARKET WOES

Corroborating the lofty expectations of public market investors, private market participants have yet to come close to realizing AI promises. In 2023, Sequoia Capital, Silicon Valley’s preeminent venture capital firm, estimated that companies spent $50 billion on Nvidia hardware but only brought in $3 billion in revenue. Granted, productivity gains from generative AI should translate into revenue increases over time. As previously discussed, enterprises must overcome data storage, data availability, cybersecurity, and bureaucratic and financial obstacles before AI model implementation, which will take several years for non-software firms.

As we highlighted last week, high-profile startups are starting to fail, as Inflection AI shuttered its consumer-facing chatbot and integrated it into Microsoft’s enterprise-focused effort. Stability AI’s future is unstable after founder Emad Mostaque’s downfall. In an in-depth report by Forbes, company insiders revealed its financial shortcomings. Stability AI’s astronomical infrastructure costs left the AI firm with just $3.81 million in reserves. According to internal company documents, Stability AI spent over $94.39 million per year to cover cloud computing costs from Amazon, Google, and GPU cloud operator CoreWeave. Once valued at a billion dollars, Stability AI is financially insolvent. Its downfall highlights the additional risk of in-house AI model development, an extraordinarily capital-intensive endeavor.

🔑KEY TAKEAWAY

Most modern revolutions endured a boom-and-bust cycle before widespread adoption—PCs, the internet, and now generative AI. Tempering expectations eliminates hype. But when dollars detach from reality, bubbles inevitably build. Hopefully, the next farce won’t come as quickly as the last.

📒FINAL NOTE

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