April 19, 2024

The market’s love affair with AI stocks may have delayed a bubble burst, but one is still on the horizon and it could result in a recession, warned GMO’s chief investment strategist Jeremy Grantham. The co-founder of the Boston-based investment firm said in a paper Monday that AI’s “bubble within a bubble” could start to deflate.

His warning goes a against forecasts from some other analysts. Analysts at JPMorgan said Monday that the S&P 500’s “Magnificent Seven” tech stocks are actually undervalued and could fare better than other stocks. Nvidia, the member of the seven most related to AI, is already up 87% this year.

AI bubble with a bubble

Grantham argues that the the investment frenzy for AI stocks spurred by the launch of OpenAI’s ChatGPT in 2022 temporarily delayed the bursting of the 2021 COVID stimulus bubble.

He says that 2021 had all the telltale signs of a bubble peaking: investor euphoria, companies rushing to go public, and “highly volatile speculative leaders” starting to fall early in the year, with things getting worse the following year.

“In the first half of 2022 the S&P declined more than any first half since 1939 when Europe was entering World War II,” Grantham wrote.

This apparent burst was paused by what Grantham describes as a “bubble within a bubble,” as investors took a breather to admire AI stocks.

He concedes that AI could likely be as game-changing as the internet. But like all technological revolutions, he said, they usually don’t reach their full potential until after an initial bubble burst. He used Amazon as an example of this phenomenon.

“Amazon led the speculative market, rising 21 times from the beginning of 1998 to its 1999 peak,” Grantham wrote. “Only to decline by an almost inconceivable 92% from 2000 to 2002, before inheriting half the retail world!”

Grantham continued that once the AI bubble starts to deflate, the original market bubble will follow and end with a recession.

“It also seems likely that the after-effects of interest rate rises and the ridiculous speculation of 2020-2021 and now (November 2023 through today) will eventually end in a recession,” he wrote.

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