The AI stock bubble may be popping

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The artificial intelligence-fueled rally that sent stocks soaring into the summer is hitting speed bumps as companies report second-quarter earnings.

Microsoft (MSFT), considered a software leader in the space, told investors late last month that AI contributions to revenue will be gradual. AMD (AMD) said it expects the market for AI accelerators to reach more than $150 billion by 2027. But the long-term projections didn't help the stock, which fell more than 7% in the next trading session as analysts feared expectations may have grown too high.

Overall, the Nasdaq Composite (AMD) is now down nearly 2% over the last two weeks, which spanned most of big tech earnings.

The signs could point to the AI stock bubble popping. On Monday, Morgan Stanley equity strategist Edward Stanley released an analysis of 70 prior bubbles over the past 100 years, including the dot-com surge and recent excitement in cryptocurrencies. The median return in three years for those bubbles is 154%. If Nvidia (NVDA), which is up 200% so far this year, and large cap tech are the proxy for how far the AI boom has gone, then it's likely "late innings" for the AI stock rally, Stanley wrote.

"With typical 3-year returns into bubble peaks of 150%, one could argue that this rally surpasses most others," Stanley wrote.

But Stanley believes the AI bubble of 2023 isn't the same as those other 70 bubbles. For one, measuring the rally is hard given that the AI index Morgan Stanley tracks is up just 50% this year, compared to the 200% surge in large cap tech.

"Judging where we are on the run-up in market exuberance is extremely challenging," Stanley wrote. "This is the case with AI today. Many investors would be forgiven for thinking AI investment funds are making new all-time highs on the back of Generative AI excitement. In fact, (they're) not. Several underlying stocks are, but as an investment theme, performance is still 14% below prior market high."

A Nvidia office building is shown in Santa Clara, Calif., Wednesday, May 31, 2023. (AP Photo/Jeff Chiu)
A Nvidia office building is shown in Santa Clara, Calif., Wednesday, May 31, 2023. (AP Photo/Jeff Chiu) (ASSOCIATED PRESS)

Wall Street buzz quieting down

AI has been the buzzword of Wall Street in 2023. It sent strategists boosting their outlook on the S&P 500. Roundhilll created a new buzzy ETF called CHAT, and investors have been searching deep into the world of tech to find the next big AI winner.

Entering second-quarter earnings season, the AI promise seemed to still be fueling stock jumps. In July, a Bloomberg report about Apple working on its own form of ChatGPT sent the stock up about 1%. A day before, Microsoft shares rose about 4% as the company announced pricing for its M365 Copilot AI product. Both stocks finished at all-time highs on the day the developments broke.

But when prompted to give specifics on AI projects, Apple (AAPL) CEO Tim Cook didn't bite. He called AI and machine learning "core fundamental technologies that are integral to virtually every product that we build," without expanding too far into coming products like the ChatGPT-style bot Bloomberg mentioned.

"We tend to announce things as they come to market," Cook said. "And that's our aim and I'd like to stick to that."

While a lack of AI excitement likely didn't drive the negative price action on Apple's stock, companies that have played up their AI success aren't benefiting as much this quarter either. With the exception of Meta (META), which attributed AI to boosting revenues in the current quarter, investors have seemed more concerned with the current state of things rather than celebrating potential AI benefits to come down the line.

Snap (SNAP) boasted more than 150 million users have engaged with its My AI chatbot.

But Wall Street appeared stuck on the cost of the investment. The stock fell more than 14% after the company reported.

"The challenge here is Snap's investments to rebuild its (direct response) ad platform and offer newer products and tools to improve engagement are resulting in higher (artificial intelligence and machine learning) costs pressuring gross margins, EBITDA, and free-cash-flow," Ron Josey, Citi managing director of internet equity research, wrote after Snap earnings.

It's not just that AI callouts aren't boosting stock prices this quarter, either. Momentum has slowed for some of the industry's biggest names leading into their reports, too. Nvidia, which is expected to report earnings on August 23, has seen its stock rise more than 200% this year due to its AI prospects. In the past week though, the stock has fallen 4% in the past week and is up just 6% over the last month, suggesting the stock's meteoric rise may be taking a break.

"Post-earnings reaction could see some near-term stock consolidation following the 200%+ move up YTD," Bank of America research analyst Vivek Arya wrote on Monday.

Josh Schafer is a reporter for Yahoo Finance.

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