Sobriety Checks on the AI Highway
Sobriety Checks on the AI Highway
Someone once said that the difference between former Treasury Secretary Bob Rubin and former Treasury Secretary Larry Summers was that Rubin wanted to listen to the smartest person in the room while Summers wanted to prove that he was the smartest person in the room. I prefer Rubin’s method. What Elon Musk, David Einhorn and Bain & Co. have in common is that they all would qualify as almost always the smartest person in the room. Einhorn is the Founder and Portfolio Manager of Greenlight Capital and someone who has shown a unique and prescient understanding of the macroeconomic landscape over more than two decades. Musk, well you know Musk and Bain & Co. Insights write macro analysis that is importantly unique versus investment banking based research due to their level of critical candor toward the technology industry. They are among others who have recently expressed some concern that the level of expectations discounted in AI company multiples and the forecasts of the companies themselves have become beyond realistic.
At a conference this week, Einhorn said, “The numbers (estimated return on investment) that are being thrown around are so extreme that it’s really, really hard to understand them. I’m sure it’s not zero, but there’s a reasonable chance that a tremendous amount of capital destruction is going to come through this cycle.” In other words, he is saying that the return on investment being suggested by the AI investment leaders like Meta, Tesla, OpenAI, Microsoft and others are likely to far overstate the eventual reality. While he concedes that of course there will be some ROI, it is likely that the frenzy of spending right now will prove to be malinvestment. To be clear, Einhorn isn’t making the case that AI won’t be transformative long-term, he is saying the odds are that the massive spend being made right now on data centers and Nvidia GPU’s will likely deliver very poor returns over the foreseeable future.
This week Bain & Company published their “Technology Report 2025”. Bain walks through the simple arithmetic issue that if we take the investment forecasts of AI entities at face value, the power consumption from all these new datacenters would quickly move beyond the capacity of the US power grid. Secondly, Bain estimates that even using the most optimistic assumptions, AI derived revenue generation will be $800billion short of what is required to fund the forecasted capital investment. Bain’s research piece is important because it raises the very uncomfortable question of creative destruction. If there are new winners, who are the losers? Who loses all their business to the innovator? Amid the current environment of passive flows and frothy multiples, the market is less that discerningabout what megacap tech name will see their growth rate go from a 30% CAGR to negative? Two things that can’t coexist are rapidly growing innovators and no threat to incumbent leadership. Not all the children can be above average forever.
The above graphic was reposted on X by Elon Musk recently. The graphic illustrates in a simplified manner the concern that perhaps spending on Nvidia GPU’s are being financed by Nvidia’s own investment. Musk’s reason for drawing attention to this concept is likely because he thinks OpenAi’s comeptitors, like xAI are disadvantaged by this incestuous relationship. But it also reminds investors of a certain age of the “vendor finance” deals that networking companies like Cisco utilized at the peak of the .com bubble to keep unsustainable growth rates sustainable just a few quarters longer.
As the great Stan Druckenmiller said, “When I see a bubble forming, I buy it”. The problem is that few of us have the trading acumen and capability to time the exit as well as Mr. Druckenmiller.
Bulls make money. Pigs get slaughtered.
Tim Pierotti is WealthVest’s Chief Investment Strategist.
Tim has over 25 years of experience in various aspects of the equities business. Prior to joining WealthVest, Mr. Pierotti spent seven years in Equity Research management roles at Deutsche Bank and most recently at BMO where he was a Managing Director and Head of US Product Management. Tim has 11 years of investment experience most notably as Head of Consumer Research and Portfolio Manager at The Galleon Group, a former NY based $8Bln Long/Short hedge fund. Tim is a graduate of Boston College and lives in Summit NJ.
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