The AI Bubble May Have Already Popped. The Rally Can Still Survive.

(Dreamstime)

Key Points

• Investor sentiment toward AI has shifted, with companies like Target and Meta Platforms seeing muted or negative stock reactions to AI-related announcements.
• Meta shares fell over 20% after detailing significant capital spending for AI, and Oracle slumped nearly 33% following a large RPO forecast linked to OpenAI.
• While Magnificent Seven profits (excluding Nvidia) rose 27%, the rest of the S&P 500 saw a 14% gain, indicating broader market improvements beyond AI-driven tech.

It wasn’t too long ago that the mere mention of “artificial intelligence” in a corporate press release would trigger an upside move for the stock.

Investors, eager to get ahead of the next wave of the new technology’s potential, were happy to believe in, and bet on, a bottom-line impact from AI deployment—even if it couldn’t be fully explained.

We’re not there now.

Target attempted to sweeten the impact of a mixed set of third-quarter earnings and a dour holiday season outlook by floating a new partnership with OpenAI. The struggling retailer vowed to “leverage AI to help guests explore our assortment with ease.”

The stock barely budged.

Companies at the center of the AI investment boom are also finding it tough to secure a sympathetic ear for their lofty new tech ambitions.

Meta Platforms shares have fallen more than 20% since its third-quarter update in late October detailed massive capital spending and expenses commitment tied to its pursuit of “superintelligence.”

Oracle has slumped nearly 33% since it unveiled a massive increase in its RPO forecast that was subsequently tied to a $300 billion deal with OpenAI. Smaller players in the AI space, such as CoreWeave and Palantir Technologies, have also seen selloffs.

Nvidia, meanwhile, is largely even with the S&P 500’s 3% gain since it last reported earnings on Aug. 27. Investors are bullish on the market, but also starting to question the scale and pace of AI investments after one of the worst November slumps since 2008.

Stocks moving in the other direction, by contrast, are doing so largely as a result of faith in their core businesses as opposed to the discounted returns on AI spending.

Google shares have soared nearly 43% since a U.S. court ruled on Sept. 2 that its parent company, Alphabet, could keep its Chrome browser and Android operating system despite having lost a landmark antitrust case in 2024.

The world’s most famous value investor, Warren Buffett, recently went along for the ride.

Apple, which has failed to capture investor imagination with its long-game AI strategy, has risen around 34% since late summer off the back of robust iPhone demand that helped generate a record $102.5 billion in revenue over the three months ended in September.

Put simply, while the biggest stocks in the AI trade still dominate index performance with the sheer heft of their market values, investors are separating the wheat from the chaff in the recent pullback. And that likely means that AI will no longer be the proverbial tide lifting all boats in the stock market.

But it doesn’t mean the AI rally is over. It may just evolve differently.

Jean Boivin, who heads the BlackRock Investment Institute, sees the capex increases from the sector’s biggest players as a “necessary step in the AI buildout,” but notes that earnings outside of tech are also showing big improvements.

Magnificent Seven profits for the third quarter, not counting Nvidia , rose 27% from last year, but the rest of the S&P 500 saw much better-than-expected gains of 14%.

That can pull new investment money away from the speculative AI themes and into more traditional, income generating stocks, lowering overall market multiples at the same time.

John Belton, a portfolio manager at Gabelli Funds, also notes that the forward price/earnings multiple for the Mag 7 has already contracted by around 10% since the start of the year, even as an index tracking the group’s performance is up nearly 20%.

“That implies that earnings growth, rather than multiple expansion, has propelled share price performance,” he argues, adding that only two stocks in the group, Alphabet and Tesla, have seen their forward P/E ratios increase this year.

“This is good evidence that while earnings estimates are always subject to negative revisions, it is difficult to argue that we are in a valuation bubble currently,” he said.

And perhaps a good indication that the broader AI bubble may have already popped.

Write to Martin Baccardax at martin.baccardax@barrons.com