Watch out — 1 hedge fund investor thinks AI spending is overheated. Is it time to sell AI stocks?

It wasn’t long after ChatGPT launched in November 2022 that talk of an artificial intelligence (AI) bubble began to form.

The introduction of the revolutionary AI chatbot has sparked an unprecedented arms race in new AI technology, driving demand for Nvidia (NVDA -4.09%) graphics processing units (GPUs) through the roof and giving it a market value that is now over $3 trillion, rivaling Apple and Microsoft for the most valuable company in the world.

Many critics have pointed out that for the billions of dollars spent on AI infrastructure, there is relatively little to show for it in end-user demand for AI products and services. There is no “killer app” in AI yet, and businesses and everyday users seem to be struggling to find ways to take advantage of the new technology.

One such skeptic is David Cahn, a partner at Sequoia Capital, a well-known Silicon venture capital firm and backer of at least 70 AI companies. Cahn wrote a paper in June saying the AI ​​bubble is reaching a tipping point.

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A $600 billion AI deficit?

As Cahn sees it, the tens of billions of dollars being spent on AI infrastructure must generate an even greater amount of revenue for its owners to justify the expense.

For example, based on back-end calculations, he estimates that if Nvidia’s data center revenue reaches $150 billion by the end of the year, then companies spending $150 billion on those Nvidia components should generate $600 billion in revenue to recoup its investment.

That calculation is based on data center chips that account for half the cost of running those data centers and a 50 percent margin for software running on those cloud infrastructure services that buy Nvidia hardware like Amazon web services, Microsoft Azure and Google Cloud.

He also claims that the supply shortage at the end of 2023 has narrowed, GPU stocks are rising, and pure-play AI companies are making only minimal revenue, with the vast majority returning to OpenAI. OpenAI recently hit $3.4 billion in annual revenue, but it’s also on track for a $5 billion loss this year.

While Microsoft has talked about spending on Azure OpenAI, for example, Cahn correctly points out that direct revenue from generative AI is relatively negligible so far.

There is more to the story

Despite his belief that AI is in a bubble, Cahn characterized the bubble as short-term, saying he believes “a huge amount of economic value will be created by AI.”

However, he also called the current environment in AI, both among major cloud infrastructure players and investors, a “speculative frenzy,” meaning there will be a substantial decline in valuations for stocks like Nvidia and his colleagues.

Big tech companies like Alphabet and Microsoft are already receiving pushback from investors over their steep increases in AI capital spending, as both stocks sold off after their earnings reports, and that resistance is likely to grow quickly until investors are convinced they can generate the kind of income amounts Cahn explains above.

Is it time to sell AI stocks?

It’s likely that at some point there will be some sort of pullback in AI stocks like Nvidia, as the first sign that demand isn’t as strong as expected, or that GPU prices are starting to drop, will send investors scrambling. towards the exits.

Yet there’s a reason so many tech titans believe generative AI is as transformative as the Internet, and why the stakes are so high. It’s still very early in the new technology’s ramp, and it will take years for its utility to grow and make today’s spending seem reasonable.

When you consider innovations on the horizon such as self-driving cars, artificial general intelligence (AGI), and the creative potential of generative artificial intelligence, the technology will be disruptive if it works, and in order to work, it requires the massive infrastructure being built. now.

While a decline in AI stocks is likely, the long-term future still looks bright for the AI ​​sector, as the technology appears poised to be as transformative as its champions hope. A temporary pullback should not deter long-term investors in AI.