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- [00:00]
A
Today's episode is sponsored by Trading 212 the platform bringing commission free investing to everyone. Welcome to many happy returns where we aim to make you a better investor. I'm Romin.
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B
And I'm Michael.
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The AI boom has all the signs of a bubble, an exciting new technology, stretch valuations, extreme concentration, circular financing and uncertain cash flows. But how does it all end?
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Fidelity's Tom Stevenson joins us. To game it out, adopt style, pop a slow puncture, or is this time really different? Okay, let's get into it. So we're delighted to be joined by Tom Stevenson, who's investment director at Fidelity. He's had a 20 year career in financial journalism and is the Daily Telegraph's long serving markets columnist. Thanks so much for joining us, Tom.
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C
It's a pleasure. Thanks for having me on.
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B
So, over your career and your time covering markets, I'm sure you've seen quite a few booms come and go. How does this one that we're currently in compare, do you think?
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C
Well, I think in terms of scale, it's getting up there with previous booms that I've lived through. And I'm thinking particularly about the dot com bubble now 25 years ago. I think there are a number of fundamental differences between what's happening today and what happened a generation or so ago. And I'm sure we'll get into some of those. But certainly, I mean, I think there is a very valid question about whether we're talking about a boom or a bubble. And I think the jury is out on that at the moment. But clearly in terms of the scale of the gains in the stock market, this is very significant.
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A
I've read that in order to have some kind of transformation in society with a new technology, you have to have a bubble. Do you think that's a fair description?
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C
Well, I mean, I think when we look at what's going on with AI, it is important to separate out the hype from whether we're talking about a long term transformational change of the economy. And I think that both can happen at the same time. So I think that's an interesting way of framing it and I wouldn't disagree with that. I think if you look at the transformational technologies in the past, things like the railways, the introduction of electricity, the Internet, there was certainly, well, both with railways and the Internet anyway. There was an associated investment bubble as well. So whether it has to be be there or not, I don't know, but it very often is.
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B
Which parts of the market do you think have potentially got ahead of themselves because we've seen valuations run up first across Nvidia and the chip makers. Latest one is these memory stocks who just can't make RAM fast enough. Basically this DRAM is just flying off the shelves. If you look at the South Korean stock market, it's pretty insane. And any kind of infrastructure related to AI seems to be getting bid up.
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C
So I think the market is clearly getting ahead of itself in some cases, and you've mentioned two of them there. Clearly the focus at the moment is on the underlying building blocks as the infrastructure that will underpin the AI transformation. And I think that's not unexpected. Markets always anticipate where the gains are going to be and in most cases they will overcook it when, when they do that, when they go through that process. So we've seen that in semiconductors and I think that we will probably see it going forward in other areas of infrastructure associated, and that may be areas further downstream in terms of data centers and the power generation, the electrical equipment, et cetera, et cetera, which is all part of this infrastructure build out. But I think the question about whether it's over its skis, whether it's really ahead of itself, comes back to whether the investment, the spending is genuinely sustainable and whether it's supported by real earnings growth. And I think at the moment, and this is what really distinguishes this boom, I think from the boom 25 years ago, is that it is supported by real earnings growth and that is limiting the valuation of excesses, which I think are much less than they were 25 years ago.
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B
I suppose the question is, could you have a bubble in earnings growth? Do you know what I mean? It might not be a bubble in the valuations, but that earnings growth might be a short, sharp tick upwards and then that's it.
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C
That is a real consideration. Once the spending is in place, once the basic infrastructure has been created, then there's a sharp fall off. I think that that may be true, that this is not going to be a straight line and there will be setbacks. But for me it feels like this is such a fundamentally transformational technology that I think there will be ups and downs, there will be dips along the way, but it feels like this is a sustainable boon. I think the key consideration here is that what we're talking about here is a general purpose technology. This is not something which has a specific benefit to one area of the economy. There are so many different areas where this is going to enhance productivity. Whether that's in automating, routine administrative Tasks, whether it's in more efficient manufacturing, whether it's better, faster, enhanced software development within the healthcare field, accelerated research, better diagnostics, just in a general business context, better customer service. There are so many different areas in which AI really has a significant potential to improve productivity that I think that gives it legs.
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A
As the UK economy is largely a taker of this economy rather than a maker. Do you think as a services economy could this actually help the uk, make us more efficient, maybe provide our services more effectively?
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C
I think that the productivity improvements are a credible, probably the most credible way to dig us out of our economic problems in the UK. I mean fundamentally for the last 10 years and more, more than that actually going back to the financial crisis, the productivity gains in the UK have been more or less non existent and I think AI does have the potential to change that.
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B
It's just a shame we're going to have to buy it in, I guess from America or potentially China. It seems like our high electricity costs and aversion to anything anywhere is going to really hamper us in terms of owning the underlying technology.
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C
Yeah, I agree with that. I'm not quite sure what the answer to that in the short term is and it's not a reason not to attempt to benefit from the advances.
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I'm just looking at how this has been funded and I think there's a lot of debt that's been used in order to fund the hyperscaler growth. So I'm looking at some estimates right now. UBS thinks that the aggregate capex would be more than 770 billion this year alone and a lot of that is in the form of debt. So effectively it comes with a clock.
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C
So yeah, some of it is. I think one of the key differences though with this investment cycle is that so much of it is being funded by extremely profitable cash rich companies. So I mean if you look at the main hyperscalers, they're probably generating operating cash flow in the hundreds of billions of dollars, maybe half of the number that you mentioned there is going to come from operating cash flow. So yes, I think that the big companies are raising money through the debt markets. I think they're not doing that because they have to, I think they're doing that because they can and they have the opportunity to do it and it makes sense for them to do that. So I think that the funding for this is going to come from broadly three sources. It's going to come from operating cash flow, it's going to come from some debt and I think third, it's going to come from equity raises, but I'm not too concerned about that. I think the sort of scale of the equity raises that we've seen so far, while they're big numbers in the context of the size of the global and especially the US Stock market, they're not really that large.
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B
I did see that there's some analysis which shows that next year 2027 is likely to be the first year in. I think it's more than 20 years where there is a net issuance of stock in the US RA rather than a contraction through buybacks and taking private.
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C
Yeah, and I think that that does have an impact on the market and on the future direction and trajectory of the stock market. I think that one of the key drivers of the stock market over the last 20 years or so has been the equity, which has been taken out of the market through share buybacks. And I think if that reverses, then that is a potential threat to the continuing bull market.
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One concern I've heard is that there is circular financing which is funding a lot of this development. For example, a chip maker funds an AI lab where money flows into the cloud and then back to chips. So Nvidia has invested in OpenAI, for example, and then OpenAI has given hundreds of billions of dollars to Oracle. Oracle buys Nvidia GPUs and so on. Do you think that's a threat if the whole pack of cards comes down?
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C
I think it's an important element of what's going on with the financing. And I guess the way that I would frame it is that it potentially creates something of an illusion of demand. So as you say, you have the hyperscalers investing in other companies who then spend money with the hyperscalers. And you do get this circularity of demand, which is potentially not real demand. It's not related to real end business demand. For me to be concerned about it, I'd want to see a mismatch between the apparent demand indicated by the revenue numbers for these companies and the actual demand from end users. If you started to see a mismatch between the two of those, then you might think that that can be explained by the circularity. I don't think we're necessarily there at the moment. It feels to me like there is genuine business demand because businesses across the board can see the enormous commercial benefits of implementing AI. So I think that it is real demand, but I think it might be exaggerated a bit by this circularity.
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B
My big question around the sort of real organic demand is demand at what price? Because at the moment these AI labs are offering their products on a subscription basis, at least to consumers, and what might be charged, even a high priced subscription of $100 a month or $200 a month, is actually costing them thousands of pounds to serve that. So it's sort of being funded in the same way, in a way that Uber's rollout was subsidized by venture capital. When the price reflects the actual cost, assuming costs don't fall massively, will demand suffer? Do you know what I mean? Do you see the distinction here in this early stage?
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C
I totally understand what you're saying, yeah. I mean, essentially it's a kind of lost leader, isn't it? I mean, it's being given away in anticipation of real paid demand further down the track. I mean, just anecdotally, I mean, from my limited use of AI within my own life, I can sense how quickly it has become an essential part of my expenditure. So I can see, and just anecdotally, talking to friends and colleagues, how many of them are prepared to pay quite a significant amount for unlimited access to AI. So I think it's not an unreasonable bet that the demand will be there and people will pay for it. But I do think it's a risk.
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B
Yeah, it depends what you're comparing it to. So I hand anthropic £90amonth, and if you didn't know anything about AI, you'd be like, that's crazy. But if you think how much would it cost me to have a personal assistant at my beck and call all the time who's super smart? Well, £90amonth is a blooming good deal for that.
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C
Absolutely right. And extrapolate that to the broader economy, then that kind of justifies the bet that they're making.
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Do you think these points about people taxing AI as if it's an employee, because if it's doing an employee's job, perhaps that's the way we should tax AIs, maybe as if they're kind of people. Would that be reasonable, do you think?
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C
Wow, that is a complicated issue for governments to decide. I genuinely don't know the answer to that. But I do think the impact of AI on the labor market and therefore on how governments spend their money is one of the most significant unanswered questions here. There's a fiscal element to that, but there's also a social cohesion element to it. Taxation is a part of that equation. It's beyond my pay scale at the moment to really find an answer to that.
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B
I mean, I'VE heard people worrying about the fact that if AI does deliver what is claimed, then it's kind of self defe because you put a lot of people out of work, there's less discretionary spending in the economy, the economy goes down, it turns out to be a massively deflationary technology. But I don't think anyone knows if that's going to happen. We just have to sort of invest without knowing.
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C
Yeah, I mean, I think the broader economic implications of what's going on here are super interesting and unknown and potentially you said it self defeating, you know, because clearly I think AI could be too successful. That may be one of the tail risks of AI is that it simply does too fantastic a job and it destroys other areas of the economy and it destroys spending power and so undermines the consumption side of the economy and undermines the employment potential of whole swathes of the economy.
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B
But the question we're really here to ask is how do we get rich in the meantime, where would you be looking as an investor right now? Because I think no one knows if it's going to be a boom or a bubble. Truly.
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C
Yes, I mean I think that like any boom, you have to ride it because the opportunity cost of missing out is simply too enormous. So that becomes extremely risky and the longer it goes on, the riskier it becomes. So how I would manage that as an investor is to create as much diversification within this theme as I sensibly can. So for example, I think you have to follow the early winners, the areas where we talked about it getting ahead of itself, the semiconductors, et cetera, the early beneficiaries. But then I think you need to look further forward into who ultimately the user beneficiaries of the technology. So I would highlight financial services, services, healthcare, the industrial sector and business services as four very obvious areas in which the user will benefit even more. And this was the pattern with the Internet, that it wasn't the early creators of the Internet who were ultimately the big winners. The big winners from the Internet were the ones that worked out how to use it to enhance their business productivity and profitability. So I think that's the first step is to look to diversify into the end user beneficiaries. Then I think there's an element of tapping into the downstream beneficiaries in terms of infrastructure. So the power generators, cooling equipment, electrical equipment switching, etc. Data center, real estate companies. So I think there's a downstream element. And then I think you need to think about just having broader diversification within your portfolio, away from the AI theme. Yes, it's important, but it mustn't be the whole story. That's where the risk is. And I would also just actually think more broadly in terms of an element of my portfolio that moves away from just the growth story towards a more value element to my portfolio. Dividend payers in particular.
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Yeah, it's interesting. Value stocks were actually dominated by chip companies until quite recently, so that would have been a great trade. But now maybe not so much.
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C
Yeah, well, I mean, that's the thing about value and growth is that they're not fixed entities. Companies move between the two.
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A
And a further question actually is about looking a bit further into the future. Now, I just did a video about embodied AI and what's interesting there is that initially it seems as if it's services which are being impacted people who work at a desk, whereas if we have embodied AI, well, suddenly there's a massive swath of the economy which is potentially going to be disrupted. So how would you think through that transition process?
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C
Yeah, I'm glad you raised that because I think that is a really interesting element. So, I mean, the first phase of AI has clearly been a sort of a cognitive, a digital aspect of the technology. And I think the next phase that we're moving into is where AI becomes embedded in the physical world, you know, some kind of humanoid robotics. And it broadens out the potential beneficiaries of this away from some of those sectors that I mentioned, the financial services, the business services, into areas of employment, for example, whether that's care for the elderly or whatever, areas which you would not automatically think of as being a beneficiary from AI. So I think that massively enhances the whole opportunity set.
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B
And is this where China might come to the fore?
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C
Well, I think it potentially could because I think China has leapt ahead in terms of its understanding and ability to benefit from this sort of physical automation. I think also Japan as well. I think Japan is an interesting beneficiary of the more physical side of the
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AI transformation, because at least China has the ability to manufacture at scale, clearly, and ramp up hardware production, where we are a bit less used to doing that recently in the West.
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C
Yeah, absolutely. And this is another argument for a geographically diversified portfolio. This is not just a US story or a Korea and Taiwan story. I think China, Japan, they come into the mix.
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In reply to that embodied AI video, there was a brilliant comment where someone said if London Transport said they were going to automate all the trains, there would be a massive strike, maybe a general one. I wonder how industrial unrest will affect the future of AI.
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C
Yeah, well, I mean, this comes back to my earlier comment about the social cohesion element of AI. I mean, I think that already we are seeing a lot of anxiety about the impact of AI on the jobs markets and how it's creeping up the skill level. It's no longer just a problem for lower skilled workers, it's creeping up. And that has big implications for governments as well because. And also the cost implications. If you've got to manage that social disruption, that dislocation, that is a very expensive thing for a government to do. And these are in most cases governments that don't have a lot of spare cash
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A
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B
We focused a lot on who might be the winners if AI delivers on its promises. But there's inevitably going to be losers as well. And we've seen the hints of that in the stock market, where it's looking at a lot of software companies and we had the kind of saaspocalypse, as it was called, where everyone was worried that basically Anthropic and OpenAI are going to eat everyone's lunch. Software as a service might be over. Whether that's true or not, again, we're probably too early to know but as we go through this, as well as the winners, there are going to be losers in your portfolio.
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C
There are going to be losers in your portfolio. And I think I come back to my point about diversification because at the moment it is simply impossible to know where the chips are going to fall in terms of the winners and losers. And that is true of any industrial transformation. You think about the introduction of the internal combustion engine. I mean, the implications of that in terms of the way cities were built, the creation of suburbs, far fewer horses running about, far fewer horses running about, you know, but at the time. And the telephone, you know, the introduction of the telephone, who would have thought that, you know, the telephone would actually be essentially a mechanism for transferring data, not voice calls. You know, you don't know when these technologies arrive. You know, even the most farsighted people can't really have a sense of, of where they're going. And I think that that will certainly be the case. And so the only way that you can protect yourself from that is to create diversification in your portfolio.
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B
Ironically, concentration in the stock market is about as high as it's ever been if you just bought the passive index, which is generally the kind of thing that we would do in our own portfolios.
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C
Yeah, I mean, concentration is an important element of this story. I think one of the important factors though is that the concentration is to a large extent a consequence of the success of these companies. So in a way that reduces the risk and the danger of it. These are highly successful companies. And I think that makes it different from the dot com bubble where the concentration was more fragile, I would suggest. But clearly there's an index risk here. The main indices are extremely concentrated. In the US top 10 companies are what, 40% of the market? Something like that. It's a huge index risk. And clearly there's a valuation risk because there's a handful of extremely highly valued companies here. And we have been here before with the Nifty 50 in the 1970s and it doesn't always end particularly well. So I do think concentration risk is something to be concerned about, but it's not unique and it's not the first time, it's not unprecedented. We have been here before.
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B
And every time you decide to move away from a cap weighted index, inevitably it just gets more concentrated. And you're like, why did I do that?
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C
Yeah, absolutely. I mean, I think there is a good argument for balancing that with some sort of equal weighted exposure. But. But it feels pretty painful when it
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A
doesn't work in terms of the macroeconomic effect of AI. I think the difficulty at the moment for central banks is how do they approach this? Kevin Walsh, for example, has clearly stated that he thinks AI will be disinflationary. So he's more likely to have lower interest rates than he would be if he didn't believe that. Obviously at the moment we're seeing all these inflationary effects, but maybe that'll make him paddle against the tide.
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C
So I think that is the interesting element of the inflation story is that they're both true. In the short term, I think AI is going to be inflationary because it is sucking demand for power, for commodities, for electricity and for labor.
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B
In terms of building these actual data centers, you need people air building them.
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C
Yeah, absolutely. And if we move into the second phase of physical AI, then the strains on commodities will be even greater than they are currently. So I think in the short term AI is clearly inflationary. I think in the longer term because of the things we've been discussing in terms of the labor market, then I think it is a deflationary impulse. So that makes the job of central banks extremely difficult.
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B
So I think it's fair to say we're all neutral on the question of boom versus bubble right now. But let's assume it is a bubble and the cash flows don't justify the expenditure that's going on right now. Those future cash flows don't deliver massive profits. What could be the trigger that causes a RE rating and would it be rapid or would it be slow?
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C
I guess there are three ways this could end. We could have a sudden bust, a sudden sort of light bulb moment in the investment community where they realize that this is not going to justify the investment and they derate quickly. That feels to me like the least likely option because of the way in which this boom is being underpinned by really strong earnings growth and real genuine demand. The second possibility is that this is a continued boom that carries on for several years and extends the bull market, which is already 17 years more than that. 18 years old. 17 years old, yeah. So it's right at the outer limits of the two big bull markets in the post war period in the 50s and 60s and in the 80s and 90s. We've already done that. And I think that a very real possibility is that this extends and becomes the longest post war bull market. What we all hope for is the sort of slow deflation of the bubble story and it just sort of settles down and evens out. That isn't really how markets work. Markets tend to Overshoot and pull back again. And so I think that we are very likely to have a significant correction at some point. That's not the same thing as saying that that's the end of it. I think that we should expect quite a lot of volatility ahead. But it feels to me like this is a genuine transformational story.
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B
I wonder if the technology itself could cause a trigger. For example, if we got Deepseek 2.0, the story where China just jumps ahead suddenly with an open source model and everyone goes, why am I paying massive subscription fees to OpenAI and Anthropic and why am I buying all these Nvidia chips? That could happen. Maybe it's unlikely. People in the technology themselves say that's unlikely, that they could do that, but you never know. Or governments step in like we've seen over the last week from the US and literally say you can't sell your product, which is not good when you're trying to make money.
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Right?
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C
Yeah. I mean, I think there are tail risks in both directions. And in terms of the negative tail risks, which is what we're really discussing here, I think the inability, potentially inability to supply the energy required is one significant one. I think think the geopolitical fragmentation affecting supply lines of things like semiconductors is another one. And then the third one is what we've already talked about, essentially AI eating itself, eating the economy, eating everything else.
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B
So you're looking at kind of like big changes, changing investors minds. Do you think it's unlikely to be triggered by just Nvidia having one disappointing quarter and everyone panicking?
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C
I think that's unlikely. I think that the nature of booms and bubbles, if that's what it is, is that the trigger, the catalyst for the end, is always unpredictable and it comes out of left field. And I suspect that you're right, the trigger could be something technological. It will be some advance that we don't see that renders obsolete a lot of the investment that's already been made.
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B
But what about the good old fashioned one? Inflation runs hot, rates rise and people panic that you need cash flow sooner than you thought?
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C
Yeah, absolutely. And I think that given that this is a growth focused technological boom, I think that the inflation question and the bond yield question is front of mind here. I think that is extremely plausible as a trigger to end this.
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A
We've talked about the negative aspects of this and the downside tails. I'm quite excited by the technology. I use it a lot and particularly for coding. It's just been amazing. I mean, not Just slightly different, but transformative. So I think there could be a lot of upside. Maybe you'd like to touch on what you think would be the greatest benefits of AI?
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C
I guess I'd point to three things. I think that first of all, I think it's possible that we are simply underestimating the scale of the productivity gains which can be achieved. And if you look at previous transformational technologies such as electricity, I think that society as a whole massively underestimated what the positive benefits of that would be to the economy. And I think there's a risk that we're doing that with AI. I think the second area that really interests me is the potential for AI to accelerate and enhance scientific discovery. So I think in terms of finding cures for terrible diseases and very expensive diseases, that is transformational. And then I think the other, the third way in which we may be underestimating this is just the speed with which the benefits can be monetized. So we worry about we're not going to get a decent return on this massive investment, but what if the monetization is just much quicker than we expected? Then suddenly that investment just seem. Seems like an absolute bargain.
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B
These are the fastest growing products, I think, in human history.
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C
Absolutely right. I mean, this, you know, this is, you know, all transformations are unprecedented. We haven't done it before, but, you know, it's human nature to focus on the risks and the dangers. You know, that's how we survive.
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B
Certainly my nature, I think it's most
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C
people's, it is human nature. I mean, that's how we start alive, being aware of the risks and looking for patterns. But I think there is a greater risk is that we don't get on board and see the benefits.
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B
Because in the intro to this episode, I asked could this time be different? And it's almost a joke, isn't it? Investing this time is different. It could be different, and it never is, and it very, very rarely is. But sometimes it is. I was looking at a graph of global GDP that economists had put together going back 10,000 years ago. And for almost all that time, it's just crawling along the X axis. There is no GDP growth. Effectively, we're all farmers and we just have to grow our food. But then you have the Industrial revolution and it basically just goes a vertical line from there. And this is a potential for another industrial revolution. We don't know if it's going to play out like that, but it has that potential.
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C
Right?
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B
If you have a country of geniuses in a data center and almost infinite PhDs everywhere. That's got to be transformational.
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C
I totally agree with that. And I think that I was talking to a fund manager recently who's very positive on the whole AI story, and he was an early investor in Nvidia and he totally bought it and he just described it as being this is the Internet. On a scale of it's 100 times the Internet. This is not just the Internet. A bit better. This is 100 times the Internet. You know, it sounds implausible. It sounds like wishful thinking. It sounds like the kind of thinking that we had in 1999. But what if it's true?
- [34:21]
A
Well, Tom, thank you so much for joining us. That was such fun talking to you. It's something we've been talking about for a long time, so it's nice to have a third voice and to hear your opinions.
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C
Well, thank you very much for having me. I really enjoyed doing this conversation.
- [34:35]
B
Thanks so much. Thank you for joining us for Many Happy Returns. Keep sending us your questions, no matter how dumb@mhrsioncraft.com and do remember to check
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A
out pensioncraft.com for all the information about our membership courses and investment coaching options.
- [34:53]
B
Many Happy Returns is a Pensioncraft production co hosted and executive produced by Romin Nikiza and Michael Pugh. This podcast is for informational and entertaining purposes and is not financial advice. We do not provide recommendations or endorse any decision to buy, sell or hold any security. We cannot be held responsible for any actions listeners may take and investors are encouraged to seek independent financial advice.