Right after Nvidia’s earnings affirm AI boom, Deutsche Bank warns on historical busts

“We are currently in the midst of a once-in-a-generation private sector capex boom as AI mania sweeps the world,” Deutsche Bank analysts led by Jim Reid wrote on the heels of Nvidia’s fourth-quarter earnings report, which largely affirmed a positive near-term trajectory for this spending binge.

The bad news about booms, however, is that they tend to lead to busts.

The analysts examined past instances of sector-specific massive upswings, from the 1790s canal mania in England through China’s recent urbanization and land boom, to see what these episodes have in common and any distinguishing factors between them and the current AI investment campaign.

They found the typical features of a boom-bust cycle are:

• Asset price inflation (check!)

• Leverage and debt dynamics (no check!)

Megacap tech companies are financing their AI outlays out of their massive cash-generating prowess. 

“This reduces the systemic risk of a dramatic slowdown in demand for AI products and the components that go into creating them,” they wrote. “On the other hand, US net wealth as a % of disposable income has never been higher than in the last 3 years, and the equity market has never been so concentrated in terms of exposure to the largest market cap stocks that are heavily investing in AI capex.”

In a world where consumer spending is more reliant than ever on the highest-earning Americans, and higher-earning Americans tend to own more stocks, the channel for a stock market drawdown to have a meaningfully negative impact on consumption (and fuel a bigger stock market drawdown, and so on) appears fairly wide.

That megacap tech companies in the S&P 500 like Microsoft, Meta, Amazon, and Alphabet have traded with such a weak relationship to one another even while most pursue a similar investment strategy has been a marvel to behold, and something that almost certainly won’t hold up in the event of a bust. (Per the old market adage, correlations go to one in a crisis.)

“If we do see a temporary AI winter, where market enthusiasm wavers for a period of time, it could dramatically impact wealth in the US and could disrupt the economy even if a destructive debt unwind is highly unlikely,” they wrote. “If there is an ‘AI winter’, what we have learnt from history is that behind all of these capex boom and busts there has been a common thread: over-optimistic assumptions of future profitability behind technologies or investments, which ultimately either improve productivity immeasurably, or create superb infrastructure for the future.”

But for those inclined to don rose-colored glasses, there’s also this:

“There are also capex booms that were transformative to economies and productivity but which did not experience a bust phase. These include the interstate highways in the US, the post-WWII Marshall plan reconstruction of Europe, the electrification of economies, the Apollo missions, nuclear power and even the current renewables wave.”