{{ That difference in scale is both alarming and — conversely — a comfort. The wealth and power of these A.I. companies are partly why Jerome H. Powell, the chair of the Federal Reserve, sees no cause for worry. These companies “actually have business models and profits and that kind of thing,” he said in October. “So it’s really a different thing” from the dot-com bubble.
To a large extent, the dot-com boom was a revolution from below. People around the country packed their bags and headed to San Francisco in the hopes of striking it big, just as they did in the original gold rush 150 years before. More than 2,200 dot-com companies went public between 1996 and 2001. At the time, it seemed like a lot. }}
Ai is a revolution brought to you by trillion dollar companies with earning and profits. They’ll survive an AI bubble and downturn.
But will their overblown stock prices, inflated by bubble psychology and borrowed money, survive the deflation of the bubble when investors realize the profits from AI (if any) won’t justify the capital expenditures for years?
Probably not. Maybe trillion dollar market cap Tech stocks drop by 50% and the S&P 500 drops by 20%, Hardly the end of capitalism for Long-Term Buy & Hold investors.
Why? The mag 7 are 35% of the S&P500. If 35% drops by 50%, the whole drops by 17.5% from their contribution. Even if you assume the other 473 companies also drop by some amount, it could still be a total drop of about 20%. Furthermore, maybe not all 7 drop by that much, maybe 4 of them drop by 50% and the other 3 drop by 25%?
The thing that will cause the S&P500 to drop like a rock is an AI bust ACCOMPANIED by a credit and/or banking issue. That could easily drop the S&P500 by 50%.
Because it isn’t just the mag7 that are depending on AI to be a success. A myriad of other companies are betting on AI to generate revenue or lower expenses and if the mag7 are losing 50% because of AI bubble popping, then many other companies that are invested heavily in AI will also suffer losses.
If the AI bubble pops resulting in a 50% loss for the mag7, then THERE WILL BE a banking issue - that is the point. Here is my marker - if the mag7 lose 50%, JPM will lose more than 20%*. It won’t be the only bank/financial institution to suffer such.
*Note, after writing this and on a whim, I asked Google Gemini, “if the magnificent 7 were to lose 50% in stock value, what would be the likely drop in value for JPM?”
The question seems to be incomplete as an exact prediction is impossible due to numerous market factors. Assuming we can estimate the JPM drop using its historical relationship (beta) with the broader market (S&P 500), and that a 50% drop in the Magnificent 7 causes a significant, but not isolated, S&P 500 decline, we can provide an estimate. This analysis assumes:
A 50% average drop in the Magnificent 7 (Apple, Microsoft, Alphabet, Amazon, Nvidia, Meta, Tesla).
This drop causes an estimated 17-20% decline in the overall S&P 500 index, assuming other stocks also fall due to market correlation (not remaining static).
JPMorgan’s stock (JPM) maintains its historical beta (market risk level) relative to the S&P 500.
My bet is that Gemini is wrong. I think it ignores both contagion and investor behavior - but of course my question wasn’t very precise as the response indicates.
Right. The AI bust - if it happens - will not just be a stock issue. It will be a debt issue.
A lot of the AI buildout is being financed by debt. Most of it isn’t debt being issued by the Mag7 companies directly, though. It’s debt being issued by the special-purpose entities (SPE’s) that are building the data centers. You’ll see a trillion dollars or whatever being invested into building these things out (building the building, buying the chips, setting up the FRICKIN’ NUCLEAR POWER PLANT, etc.), but much of that is being financed by debt. The debt isn’t on the balance sheets of the Mag7 companies - what they’re contributing are rental pledges, where they are on the hook to rent these spaces out to the tune of $500 billion over the next several years. See this article:
If all this goes t|ts up (can I say “t|ts up”? Edit: No, I can’t), then the problem won’t be just for the Mag7 companies. It will be bad for them too, of course - they’ll get hit with the loss of business prospects of AI not working out, which will be very bad for NVDA at a minimum. But it will be bad for everyone holding the debt. And that’s where the danger to the broader markets lies - not just that Amazon will have reduced prospects for making money in the future because AI was a bust, but because a trillion dollars in debt has gone bad.
We’re starting to see some very familiar financial terms being used in talking about these debt structures. “Counterparty risk.” “Credit default swaps.” “Derivative financing.” All the greatest hits from the mortgage crisis that spawned the Great Recession.
All that debt is going on someone’s balance sheet, and a there’s a lot of counterparty risk insurance that’s going on lots of other someone’s balance sheets, and if the debt goes sour it means a lot of balance sheets are going to start smelling a little funky.