🧠 The AI Hype Cycle: A Historical Perspective

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In today’s Sunday Special:

• 📜Prelude

• 🚂From Railroads to Websites

• ⛽️Cash Fuels the Craze

• 🔑Key Takeaway

Read Time: 7 minutes

🎓Key Terms

• Direct Current (DC): the stable and unidirectional electrical flow used in battery storage.

• Alternating Current (AC): the cyclical electrical flow that travels through the power lines to the outlets in our homes.

• Special Purpose Acquisition Company (SPAC): how a private company becomes open to all investors without undergoing the traditional slower Initial Public Offering (IPO) process.

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

• Graphics Processing Unit (GPU): a specialized computer chip capable of parallel processing (i.e., performing mathematical calculations simultaneously), making it ideal for complex applications like Generative AI (GenAI).

🩺 PULSE CHECK

📜PRELUDE

Since OpenAI released ChatGPT in November 2022, the number of new companies with “AI” in their name has more than tripled. At the same time, technology sector share prices have risen rapidly, with the software-heavy NASDAQ Index up nearly 60%.

Even if you’re not a Big Tech executive, investor, or market analyst, you still contribute to this hype, albeit subtly. You’ve probably pondered whether AI might take your job, maybe in casual conversations with friends. You might have shared an article about the end of coding or screenwriting, the risks of Terminator-style doomsday scenarios, or the rapid advancements of AI models. Everything we do contributes to the collective hype.

This madness is somewhat warranted. After all, The AI Pulse is predicated on AI’s transformative potential. But there’s a difference between recognizing tremendous potential and losing our minds and wallets over shiny promises from Big Tech executives, investors, or market analysts, all of whom have skin in the game. To strike this balance, let’s heed the timeless advice of British statesman Winston Churchill: “Those who fail to learn from history are doomed to repeat it.”

Here are four investment-driven bubbles from the last 200 years that propelled humanity forward in the long term but produced severe financial pain in the short term.

🚂FROM RAILROADS TO WEBSITES

1. Railroads?

In 1857, the legendary business magnate Cornelius Vanderbilt shifted his attention from canals to railways, acquiring significant stakes in various railway companies, such as the New York Central Railroad. To do this, he leveraged his wealth and savvy business reputation to secure favorable bank loans.

Across the pond, the British Parliament green-lighted 3,000 miles of railroad tracks in 1845 alone. However, just five years later, railway stocks nosedived by 67%, and a third of these companies begged their larger competitors to acquire them.

Ultimately, railroads enabled tens of millions of people to settle in the American West and Southwest, creating new markets for agricultural and industrial products. According to some estimates, removing railroads from America in 1890 would have decreased the total value of American farmland by 63.5%.

Despite the long-term benefits, the railroad industry was a decades-long process with massive spending and uncertain profits. Most borrowers couldn’t pay off their short-term loans, resulting in defects and the eventual collapse of most railway companies.

2. The War of the Currents?

In 1881, Thomas Edison launched the Edison Electric Light Company. In response, you rush to buy shares at over $1,000 apiece. After all, Edison’s Direct Current (DC) system is the next big thing. However, by 1884, the future suddenly looked less bright as the stock plummeted to $50. Then you heard about Nikola Tesla’s Alternating Current (AC) system. It’s cheaper, more efficient, and can transmit power over longer distances.

In the War of the Currents, Tesla seemed to have won. After all, AC was the preferred electronic transmitter to power the 1893 World Fair in Chicago, where 27 million people from 46 nations converged to celebrate the 400th anniversary of Spanish explorer Christopher Columbus’s arrival.

Although AC mainly powers our electricity, the smartphones, laptops, computers, microwaves, and Electric Vehicles (EVs) we rely on every day run on DC power.

The War of the Currents is one of the best examples of how competing technologies within a revolutionary field can lead to market confusion and speculation. Getting the trend right is difficult, but getting the timing right is nearly impossible.

3. Automobiles?

In the early 1900s, a skilled steam engine engineer invites you to start an automobile venture. You were one of 1,556 other businessmen who decided to enter the automobile industry. This surge of innovation and investments was driven by the excitement surrounding the potential of cars revolutionizing transportation.

However, the 1920s brought economic pressures, including high inflation levels and even higher interest rates, making it difficult for the automobile industry to thrive. In 1929, The Great Depression dealt a devastating blow to your automobile venture. By the 1930s, only around 40 automobile ventures remained. By the 1940s, only a few automobile ventures remained by adapting efficient manufacturing processing and robust market strategies.

It’s a classic tale of innovation, over-investment, and consolidation. Even when a technology is genuinely revolutionary, almost all early entrants still fail.

4. World Wide Web (WWW)?

In 1989, Sir Tim Berners-Lee proposed an invention that would transform how the world functions. It was called the World Wide Web (WWW). By the late 1990s, a stock market bubble fueled by digital startups called the “Dot-Com Bubble” led to unprecedented market growth.

There were over 2,000 digital startups, and Venture Capitalists (VCs) offered money like cheap beer at a college tailgate. Who needs revenue when you’ve got a catchy “.com” domain name?

Investments in the NASDAQ Index rose by 800%, only to fall by 78% by October 2002 because nobody knew the value of the Internet. The bubble didn’t just burst; it exploded. $5 trillion of value—poof! Gone. Every five years, half of these “.com” darlings disappear.

⛽️CASH FUELS THE CRAZE

Money drives technology hype, often at breakneck speeds. This excitement can lead to extreme valuations, as seen with NVIDIA. As AI fever gripped investors, NVIDIA’s Forward Price-To-Earnings (P/E) Ratio reached an all-time high of 80, meaning investors were willing to pay 80 times the value of its profits to own the company.

NVIDIA is undoubtedly producing essential Graphics Processing Units (GPUs) to drive devices that run AI models and other Generative AI (GenAI) applications. But we don’t know whether the company’s market value still accurately reflects its future value. Low interest rates breed irrational exuberance, as companies can borrow cheaply to fuel their growth.

Most observers expect the Federal Reserve to begin cutting interest rates. As interest rates drop below their multi-decade high, AI company valuations may inflate or deflate slowly. We may see a repeat of the Special Purpose Acquisition Company (SPAC) frenzy of 2020 to 2022, when low interest rates (i.e., cheap money) fueled a rush of technology startups going public, many with little proven long-term profitability. As interest rates rose, valuations plummeted, exposing the risks of unchecked optimism.

David Cahn, a partner at venture firm Sequoia Capital, outlined the glaring short-term mismatch between investments in GenAI and the technology’s revenue.

NVIDIA’s stock price has more than doubled this year, increasing the company’s total market value to $2.593 trillion and signaling a continuing AI boom. The technology sector has an insatiable demand for GPUs to fuel AI model training. Investors base their decisions on NVIDIA’s success, leading to rapid investments in unclear applications.

Big Tech will likely commit upwards of $600 billion in Capital Expenditures (CapEx) for AI infrastructure this year. CapEx refers to the funds a company uses to purchase, improve, or maintain long-term assets essential for its operations.

Microsoft expects to generate over $10 billion in AI revenue from products like Microsoft Copilot. Assuming Apple, Alibaba, Bytedance, Google, Meta, OpenAI, Oracle, Tesla, and X also achieve generous gains from AI, “there’s a $500 billion hole that needs to be filled for each year of CapEx.”

So, how much of this CapEx is linked to current demand, and how much is projected based on future demand? Also, what will these Big Tech companies use this AI infrastructure for? Big Tech needs to make sure they’re building AI infrastructure consumers actually want, not just guessing what might be popular later because of a “Fear of Missing Out (FOMO)” on the AI movement.

Many venture firms believe the capital investment required to build and deploy GenAI applications has surpassed the revenue it generates in the short term. GPU capacity is being overbuilt without a clear revenue stream to repay the upfront capital investment.

Perplexity CEO Aravind Srinivas believes AI will significantly improve existing business structures by allowing companies to complete tasks with limited resources at dramatically lower costs, leading to indirect revenue.

AI investment is a long-term play. AI’s potential applications through AI-powered tools, autonomous vehicles, personalized education, drug discovery, and robotics will transform industries. However, speculative investing continues to inflate technology bubbles. NVIDIA’s 2023 surge is just the latest example.

🔑KEY TAKEAWAY

Although burdened by the baggage of human nature, AI will eventually transform our world in unforeseeable ways. Think way beyond job automation—maybe a fundamental redefinition of being human is in store. In the meantime, we can think long-term (i.e., in decades, not quarters), use more precise language (e.g., what type of AI will help solve this problem and how exactly), and be cautious about market timing.

📒FINAL NOTE

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