AI's 150% rally echoes Peloton's $47 billion collapse

The Nasdaq is challenging the 26,000 point threshold, marking a rally of roughly 150% since the launch of OpenAI’s ChatGPT in late 2022 that kicked off the artificial intelligence spending spree. Megacap tech stocks have gained nearly 25% from their recent lows, while an index of semiconductor stocks has surged more than 60% to a new record high.

"The debate about whether AI will fulfill its promise as a productivity enhancer won’t be settled for quite some time,” said Jeffery Buchbinder, chief equity strategist at LPL Financial. “But what we do know is that massive spending is going to continue.”

That spending has sent valuations soaring. But for some, the frenzy brings to mind another market darling whose assumptions of perpetual demand proved fleeting: Peloton Interactive. The connected fitness company’s market capitalization has plummeted to approximately $2.3 billion from a peak near $50 billion in early 2021.

The core question for the market is whether the trillions being invested in AI will generate a return, or if the sector is repeating Peloton’s mistake of mistaking a temporary surge for a permanent new plateau. “If at some point the value proposition from AI adoption fails to live up to its hype, demand for computing capacity will slow down,” Buchbinder added.

A Tale of 2 Bubbles

Peloton’s stock surged 750% in nine months during the pandemic on the assumption that demand for its high-end exercise equipment would last forever. It did not. As the world reopened, that demand evaporated, leaving the company a shadow of its former self and a cautionary tale for investors.

The AI market is now making a similar, albeit larger, bet. The biggest hyperscale companies are set to spend $725 billion this year alone to build out AI-powered data centers. The problem, accordingto a recent PwC paper, is that nearly three-quarters of AI's economic value is being captured by only a fifth of listed companies, suggesting a widening gap between a few AI leaders and a majority of businesses still experimenting.

Another study from Workday in January showed that of the seven hours gained each week from AI productivity, nearly three were lost to corrections and reworks. The return on investment remains elusive for many, even as the spending accelerates.

The $7.6 Trillion Question

The forecasts for capital expenditure are staggering. Gartner expects firms will spend $2.5 trillion on AI this year, rising to $3.3 trillion in 2027. Goldman Sachs predicts a cumulative spend of nearly $7.6 trillion by 2031 on compute, data centers, and power.

This spending is fueling the bottom lines of chip makers like Nvidia and AMD, creating a self-reinforcing cycle: spending boosts tech earnings, which in turn justifies higher stock prices and more spending. The market is punishing any signs of this cycle slowing, as seen when Arm Holdings fell despite nearly doubling its chip revenue forecast.

The dynamic creates a disconnect where supply-side investment is treated as guaranteed future demand. But as Peloton’s experience shows, when the assumed demand doesn’t fully materialize, the reversal can be swift and brutal.

Lessons from 2008

This is not the first time markets have seen asset prices detach from fundamental value. The 2008 housing crisis provides a powerful parallel. A key warning sign then was the divergence of home prices from rents. According to research on the period, the national rent-price ratio fell to a historic low of 3.5 percent by 2006, well below its 5 to 5.5 percent historical range. Prices were rising far faster than the cash flow the asset produced.

In the housing bubble, speculative buying was rampant, with investment and vacation homes accounting for four out of ten transactions in 2005. In the AI boom, the speculation is in capital expenditure, with companies spending trillions based on the expectation of future productivity gains that have yet to be broadly realized. Just as easy credit fueled the housing boom, the belief in AI's transformative power is fueling the current investment cycle.

The lesson from both Peloton and the 2008 crisis is to watch the gap between the price being paid and the underlying value being generated. When that gap is sustained by a narrative of endless growth rather than measurable returns, it becomes a bubble. The question for investors is whether the $7.6 trillion bet on AI will be different.

This article is for informational purposes only and does not constitute investment advice.