The arrival of artificial intelligence is being hailed as a new industrial revolution and the stock market’s recent fervor around AI-related companies certainly suggests a transformative shift is underway. But beneath the surface of soaring valuations and breathless headlines, a fundamental challenge persists: investors simply don’t know how to price the future. History shows that markets consistently struggle to accurately assess the value of truly disruptive technologies, and the unique complexities of AI—its potential, its limitations, and the sheer uncertainty surrounding its development—are likely to prolong this period of mispricing. Understanding why investors won’t know what to make of AI for a even as requires looking back at how previous technological leaps were initially received, and acknowledging the specific hurdles AI presents.
The dot-com boom of the late 1990s offers a stark lesson. Companies with little more than a website and a vague business plan attracted astronomical valuations, fueled by the belief that the internet would fundamentally reshape the economy. When the bubble burst in 2000, wiping out trillions in market capitalization, it became clear that enthusiasm had far outstripped reality. Similar patterns emerged with the advent of railroads in the 19th century and, more recently, with the rise of renewable energy technologies. In each case, initial exuberance was followed by a period of correction as investors grappled with the practical challenges of implementation, the evolving competitive landscape, and the ultimate profitability of these new ventures.
The Peculiar Challenges of Pricing AI
AI, however, presents a unique set of challenges that may make it even harder to value than previous technologies. Unlike a new manufacturing process or a faster form of transportation, AI is fundamentally a general-purpose technology. This means its potential applications are vast and span nearly every sector of the economy. While this broad applicability is a source of excitement, it also makes it incredibly difficult to forecast which companies will successfully capitalize on the technology and which will fall by the wayside. The potential for disruption is so widespread that traditional industry analysis becomes less reliable.
the development of AI is characterized by exponential growth and unpredictable breakthroughs. Progress isn’t linear; it happens in fits and starts. A seemingly insurmountable obstacle can be overcome with a single algorithm, while a promising avenue of research can quickly hit a dead finish. This makes long-term forecasting particularly treacherous. As Nathan Bennett, a portfolio manager at Capstone Investment Group, told the Financial Times, “The speed of change is unlike anything we’ve seen before. Traditional valuation models simply aren’t equipped to handle that level of uncertainty.”
AI is the most hyped technology since the internet. But unlike the internet, it’s not clear what the “killer app” will be. https://t.co/q9q9q9q9q9
— Ben Thompson (@benthompson) July 12, 2023
The Role of Hype and Narrative
The current AI boom is also fueled by a powerful narrative—the idea that we are on the cusp of artificial general intelligence (AGI), a hypothetical AI that possesses human-level cognitive abilities. While AGI remains a distant prospect, the possibility has captured the imagination of investors and the public alike. This narrative can create a self-fulfilling prophecy, driving up valuations even in the absence of concrete evidence of near-term profitability.
This is not to say that AI companies are inherently overvalued. Many are developing genuinely innovative products and services with the potential to generate significant returns. However, the current market environment is characterized by a degree of irrational exuberance that is likely unsustainable. Investors are often willing to pay a premium for growth potential, but that premium can quickly evaporate if expectations are not met. The recent volatility in the stock prices of several prominent AI companies serves as a reminder of this risk. According to data from Refinitiv, as reported by Reuters, some AI-focused stocks experienced price swings of over 20% in a single week during the spring of 2023.
Stakeholders and the Impact of Uncertainty
The uncertainty surrounding AI’s valuation impacts a wide range of stakeholders. Individual investors risk significant losses if they invest in overhyped companies. Venture capitalists face the challenge of accurately assessing the potential of AI startups and allocating capital effectively. And policymakers must grapple with the broader economic and social implications of a technology that is evolving so rapidly. The potential for job displacement, the ethical concerns surrounding AI bias, and the need for robust regulatory frameworks all add to the complexity of the situation.
The impact isn’t limited to the tech sector. Financial institutions are investing heavily in AI to automate tasks and improve risk management. Healthcare providers are exploring AI-powered diagnostics and personalized medicine. Manufacturers are using AI to optimize production processes and reduce costs. The widespread adoption of AI will inevitably reshape these industries, but the precise nature of that transformation remains unclear.
What to Expect in the Coming Months
So, what can investors expect in the coming months? A period of increased volatility and a more discerning approach to valuation are likely. The market will likely begin to differentiate between companies that are genuinely innovating and those that are simply riding the AI wave. Focus will shift from revenue growth to profitability and sustainable business models.
The next major checkpoint for many AI companies will be their earnings reports in the fourth quarter of 2023 and the first quarter of 2024. These reports will provide a crucial test of whether these companies can deliver on their promises and justify their lofty valuations. Regulatory developments, particularly regarding data privacy and AI safety, will also play a significant role in shaping the future of the industry. The European Union’s AI Act, expected to be finalized in 2024, is poised to grow a global standard for AI regulation.
the story of AI and the markets is still being written. The technology is too new, the potential too vast, and the uncertainty too great to offer simple answers. Investors should approach this space with caution, a long-term perspective, and a healthy dose of skepticism.
Disclaimer: This article is for informational purposes only and should not be considered financial advice. Investing in AI-related companies carries significant risks, and investors should consult with a qualified financial advisor before making any investment decisions.
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