An Economic Bubble is Forming…Just Not for Real Estate

26:54That is not what people are saying. And in fact, not just with these hyperscalers. when you look at the people who are buying the products from these hyperscalers, so just regular businesses that are using ChatGPT or Amazon Cloud Services or whatever they're investing in, adoption is not so great. MIT just did a study and they said that 95 % of AI projects get no ROI. Another report from IBM says that only 25 % of AI projects are getting their expected ROI. So there are reasonable questions about what revenue these companies can generate in the short term. So generally speaking, there are projections that GDP will grow.

27:37There are projections that these companies will earn their valuations by increasing their revenue. There is a ton of talk and excitement, but the revenue just isn't there yet. And it has a long way to go to justify current stock valuations. Some might call this speculation. Speaking of those valuations, I think that's sort of what we need to get to because we're talking about are we in a bubble? And the bubble could burst because people feel like the stock prices of these huge companies that carry so much of the S &P. These companies make up so much of our stock market. We have to understand how they are valued.

28:15Similar to real estate, people can value things on a cap rate or a cash on cash return or whatever. There are so many dozens of different ways that you can value stocks or the stock market. But one is called the Shiller PE. It's called the CAPE ratio. If you've ever heard of this, it basically measures stock prices against 10 years of inflation adjusted earnings. So the CAPE ratio right now is roughly at 39 or 40x. So it's basically saying that's 39 or 40 times those inflation adjusted earnings. That probably on its own makes no sense. So let me just tell you that historically, the long-term average is 17x.

28:53So we're at more than double. We are now at 40x earnings in the CAPE ratio. Normally, it's at 17x. And the only other time in history that the CAPE ratio exceeded 40 was right before the dot-com burst in 2000. So this is why bears are saying maybe we're in a bubble because there are just some technical ways of measuring the stock market that are throwing off red flags. Every time the CAPER ratio has crossed 30 for an extended period, the market has eventually seen a decline of 20 % or more. So that is another argument that bears are making. The last one I want to talk about, which is a whole other big topic, and it is complicated, so I'm not going to get super into it.

29:35But there is this big thing going on where all of these companies, it's kind of incestuous. They're all like funding each other and investing in each other. It's this giant web of companies spending in and investing in one another. And it's kind of weird. You can look this up. You should Google it because I can't explain it briefly in this episode, but it's worth looking into if you're interested in this topic. Basically, you see companies, let's just use NVIDIA as an example. They're investing in AI companies and giving them money. Like they're saying, hey, we're going to invest in you. But with the money that we're investing in you, you have to turn around and buy NVIDIA chips, right?

30:12So they're saying, hey, here's some money to buy my product with. It's called vendor funding. There have been some pretty bad examples of this in the history where this has not worked out pretty well. Of course, it could be different this time. It always could be different. But it does make the system, to me, at least feel a little bit fragile. The whole thing where they're all funding each other, it just makes it seem like a little bit of a house of cards. Now, I'm not saying that's necessarily what it is, but I would feel a little bit better about this if these companies were making their money and getting their money to invest from revenue, not from one another and sort of trading and propping up the whole industry as a whole.

30:50I should say that people who are really bullish about the market think that this is a positive. Some people say it's a strength because profits are getting reinvested back into the AI ecosystem. But bears famously Michael Burry of the big short fame, who famously called the 2008 any housing crash correctly, has pointed at this as the reason that he is shorting NVIDIA and that he's getting out of the market because he thinks that this whole thing is going to collapse. You know, this is not my expertise. I recommend you look into it. But this is a big thing that a lot of experts in this field are pointing to when they're making their bearish case.

31:28So just to summarize the bear case, you would say there's really no revenue. We don't know if the money's going into the right place. valuations are already near all time highs. And can that be sustained? And there's all this vendor funding. Basically, stocks are priced right now for perfection. When I was reading some of these analyses and reports, that's the thing that kept coming up is that the way stocks are priced right now, it's like these companies have to just execute perfectly for the next couple of years to justify them. And bears think that that's unlikely. And that's why they think that we're in a bubble.

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35:45hey everyone welcome back to on the market i'm dave meyer today we're talking about the ai bubble i've shared with you a little bit about what's going on with spending the bull case and the bear case and i'll just share with you sort of how i'm feeling about after spending several weeks digging into this topic and i approached it as unbiased as i can everyone always is biased but i genuinely just like didn't have a real opinion on whether we were in a bubble or not and just started digging into this. And as I've done this research, overall, I lean pessimistic about the AI bubble. I'm not saying that it's not possible that things keep going.

36:20As I do with the housing market, I'm going to do the same thing here and say that I don't like saying X is going to happen or Y is going to happen. As an analyst, I am trained to think in probabilities. That's what we do. And I just try to think about what is the most likely thing to happen? I'm not saying that the alternatives can't happen. But I think the most likely thing to happen in the next couple of years, I'm not saying in 2026, but in the next couple of years, is that there is going to be a correction in the stock market, a fairly significant one. I don't know the timing of that. We'll talk about that in a minute.

36:52But ultimately, here's why I've come out this way. Number one, it's kind of a simple argument, but just we don't know if this is going to work. Like we just don't know. People are so excited about it, which I get. I'm excited about a lot of AI things too, but I just, we don't know if these companies are going to be able to pull off what they are saying they're going to. There's not really that much evidence of it. Yeah. ChatGPT and Gemini are super cool, but businesses aren't really adopting them. They're not making tons of revenue and they're not saying, oh my God, ChatGPT has totally changed my whole business.

37:29Sure. There are individual instances of that, but that is not happening at the scale that they need to justify the stock valuations that they are. And I am not saying, do not get me wrong, I am not saying that I don't think AI will work in some way, shape or form. I definitely think it will. What I'm saying is that the AI tools that we have right now is what I would consider a V1, a version one of generative AI. And if you think back and look at history, how many V1 technologies have failed? So many of them, right? Like how many electric cars failed before Tesla finally got it right? How many social media sites failed before Facebook took off?

38:13Remember when people were investing in Blu-ray or Laserdisc or whatever, only for streaming to take over? We just don't know what the final form or at least this growth form of AI is going to be. And yes, there are several reasons. There are good reasons to bet on these US-based hyperscalers. But this is what people always say. They always think that the incumbents are going to be there forever. If you asked people 30 years ago, will GE still be one of the biggest companies in the world? Will their investments pay off, probably everyone would say yes. Look at GE now, right? Everyone always thinks GE or Sears or whatever are going to be there forever because they can't envision something that hasn't happened yet.

39:00And then something new comes along and shocks the entire world. Now, I'm not saying it would be wise to bet against these U.S. hyperscalers, but to assume that they're going to win and win with the current technology framework and infrastructure and investments that they're making today, that is a really big if. Because like, in my opinion, even if Amazon wins, right, they might have to rebuild every data center they have. They might need to go from LLMs to something called a world model, which is a total different way of building AI, right? We just don't know. And I get that they may nail it.

39:35They may. But if you're saying that we are valuing stocks so highly because we're so confident that they're going to win, it lacks evidence. And like to me as an analyst, that's why I trend pessimistic, because until you show me evidence that these companies are going to nail the revenue side of it and earn these valuations, I'm going to lean pessimistic. And I just kind of want to build on something that I said before, because again, not saying AI won't work in some form, but these large language models, these things like ChatGPT, where you're like typing in and communicating with an AI, well, they call them agents, right?

40:08This is just one kind of AI. It is only one structure, architecture for building AI models. There are totally different ways that you can do it, right? There's something called a world model that I was starting to look into. And a lot of AI researchers think that's actually the better way to get to agentic AI, the ultimate holy grail of AI that all of these companies are trying to get to. Some of them, a lot of the leader researchers thinks that LLMs and all these investments that they're making are not the right way to go, that there's a better, different infrastructure for building AI that's smarter and more efficient.

40:44Now, I am not smart enough to know which one is right. I'm just saying that LLMs are not the be all end all. I don't think anyone agrees or thinks that LLMs in their current state are the end state of AI, that this is the best it's going to get. We're always going going to be typing to chat GPT and writing prompts and getting them back. No one thinks that. So we just don't know how we're going to get to a genetic AI. Some people think LLMs can get there. Other people think that they can't. And so I just want to show you that there's a lot of doubt about the right way forward with AI. And that means that some of these companies could be wasting hundreds of billions of dollars building infrastructure that they don't need.

41:23Like the thing I kept thinking about when I was doing this research is like, what if open AI, Super exciting company. I use ChatGPT all the time. I use Gemini all the time. I use these things. Like, I'm not saying anything bad about these. But I kept thinking, like, what if OpenAI is basically like the BlackBerry of the dot-com era, right? Remember, does anyone remember the BlackBerry? It was like kind of the first smartphone, but not really. Like, it didn't have apps. It wasn't touchscreen. It had the little trackball and the whole keyboard. I had one. And you would BBM everyone. And everyone thought, like, oh, my God, this is amazing.

41:55Like, I can text. I can go on the internet. on my phone. And everyone thought BlackBerry was here to stay, right? Then all of a sudden, the iPhone came out and everyone was like, oh, wait, this is a way better technology. That whole BlackBerry thing sucks. I'm never going to buy another BlackBerry. All I'm going to do is buy an iPhone or an Android. And now BlackBerry isn't even a thing anymore. And I'm not saying for sure that that's going to happen to AI, but like this happens all the time, even with really exciting technology. And I think there is the chance that it happens again because history is frankly filled with exciting new technologies where the first mover, the person who introduced the thing, doesn't actually win and the winner actually comes out of nowhere.

42:39And in some ways, this reality is why companies have to spend so much. They are 100 % in a race to figure this out first and to try and crush any competition and beat everyone else to the end state. But to me, that means even though one of these companies very well could win, even one U.S.-based hyperscaler could win, a lot of the other companies are not going to win. They're going to be massively inefficient, and they might spend hundreds of billions of dollars in total flops, which, of course, would negatively impact their stock prices and could pull down the entire economy. That's my number one thing.

43:15It's just like, we don't know if this is even going to work, if this is the right infrastructure. And the second reason I kind of lean pessimistic is just the revenue thing. Like maybe they'll get to$2 trillion. Maybe revenue will start to explode. But when I look at these adoption rates and what CFOs and companies are saying about their implementation of AI, they're all saying they're going to implement more. They're not saying they're getting great ROIs. And I don't see companies spending way more because there isn't a new tool like ChatGPT. Yeah, it's gotten better since 2022. But has it really changed all that much?

43:46Like, are people going to start opening their pocketbooks? Maybe they'll come out with new product? I don't know. But we haven't seen something that's really going to start driving their revenue in massive ways. Amazon's been more successful, but, you know, we'll see how that comes out. But for right now, I'm skeptical because there's just not revenue to justify these valuations. So overall, the way I'm thinking is that there is short term risk. I'm just not sure we're there yet. Like AI is super exciting, but we're betting on valuations. The stock market is basically saying, we know that these companies are going to win.

44:23That's what their valuations are telling us. And I don't see it. Like, I think they have a good chance to win. But you know, I am skeptical about buying in at these valuations thinking that they're going to go even higher. So much of the stock market right now. So I think it's about a third of the S &P 500 growth is predicated on one of these companies winning and doing it perfectly. They have to nail it because it's already priced as if they're kind of going to win. So if there are any errors, the market could tumble. And I'm not saying that means AI failed. Not at all. I just think this is kind of similar to the dot-com bubble.

44:57People were rightfully excited back then, but they made irrational investments. Ultimately, the technology, the internet, hugely impactful. And this could be happening again. People know AI is impactful and something is going to happen from it. But I think there is a risk that there is some irrational investing going on right now. Now, of course, that doesn't necessarily mean it's going to be a catastrophe. Of course, stock market crashes are fairly common. We don't like them, but they happen. And the market rises again. And I personally believe that even if there is a crash, the market will recover.

45:30But there is some really interesting data that suggests a crash now could be pretty bad. There was a recent article actually in The Economist by an economist named Gita Gupinath And she basically says since more ordinary people are investing in the stock market than any before and more foreign individuals, a stock market hit could be more widespread and have a bigger impact on consumption in the US, which I should mention drives about 70 percent of our economy, that it could have a really big hit on that. She actually calculated that if the stock market takes a proportional hit as the dot com bubble, so basically relative to its size, the same kind of decline, it would destroy $20 trillion in household wealth in the U.S.

46:13alone. This could impact consumption, of course, 70 percent of GDP. Like I said, it could impact retirement plans for the massive boomer generation whose majority of their wealth is in 401k and in the stock market. And this is where the AI potential bubble spills into real estate investing for me, because I think if we see the stock market crash, we could see demand for housing and consumer confidence decline. If this happens, yes, some things would be beneficial to the housing market. You would probably see mortgage rates drop, which would provide a floor. I'm not saying that there would be a crash in housing because of this, but I do think it could keep transaction volume low.

46:52and the sort of very normal and expected human reaction of fear would start to take over because if people see their net worths decline dramatically, they might tighten up on home buying or buying cars or moving into a new apartment. All of that could weigh on the real estate industry, especially if this potential bubble combines with some other labor consequences of AI that we haven't even gotten into in this episode, right? That's a whole other topic. But I think everyone knows that many people, even the CEOs of these hyperscalers, are saying that AI is going to have massive impacts, not good, on the labor force.

47:36And so if you combine a potential bubble and decline in$20 trillion of household wealth with a bad labor market, that could really subdue appreciation and rent growth in the housing market in the short term. So that is something to keep an eye on. And I'm not saying that that's going to be a disaster for real estate investors. I actually think when these things happen, better buying opportunities exist. And so if you're in it for the long run, that could potentially be good. I mean, people look back on 2009 to 2012 and say, man, I wish I bought then. That was during an era of fear when not a lot of people were buying and investors had an opportunity to buy good assets at good prices.

48:15So I'm not saying this is a disaster for real estate investors. I'm just saying that it's something that could happen and why, even though this is a real estate investing show, I am paying so much attention to the AI bubble because it is so big that it could really impact the rest of the market. One other thing I want to call out how this could relate to real estate investors is that if the stock market does decline by 10, 20, 30 percent, whatever, institutional investors could slow down because a lot of these, quote unquote, institutional investors are things like pension funds. They're endowments.

48:47And they have actually they've kind of rules. They have these like allocation buckets. So like they say, we're going to invest 20, you know, 20 percent in real estate, 80 percent of the stock market. That's kind of our philosophy, our investment thesis. So if the stock market drops, that actually it's kind of just this math thing, but it overweights their percentages. They're over allocated into real estate. So that means they might slow down on buying real estate just because the value of the stock market drops. And that means they could stop buying new properties. They might even sell some assets to rebalance their portfolios.

49:22You know, as we've talked about in the residential market, these companies own about two to three percent. So I'm not saying that would be crazy, but it is something that you should keep an eye out. So after all this research, hopefully this has been helpful to you. But where I've landed is I am still a little bit torn, but I lean a little bit pessimistic about the stock market and whether these valuations can be sustained. I am skeptical. Anytime our economy or the stock market is so dependent on a few companies, it makes me a little bit worried. Anytime stock valuations are honestly speculative, like let's just call it what it is.

49:57They are speculating that these companies are going to earn revenue. This isn't like, hey, they had great earnings this year and we are justifying our valuations based on that. Some of it, a company like Microsoft or Amazon, like obviously a lot of their valuation is based on actual earnings, but the run up in their valuations over the last year or so has been largely speculative. And so that worries me. Even if these are amazing companies, some of these are incredible companies doing amazing things. But the margin of error to me is just small. And so that introduces a lot of risk. And as with everything on the show, I cannot say for certain what will happen.

50:35My goal with episodes like this is just to explain the risk, just explain that that risk is out there so that you know, because I believe personally, my philosophy on investing is that risk isn't your enemy. You can invest with risk, but you have to know that it's there. You need to make decisions and underwrite your deals, understanding all of the risk that is out there. And to me, this is a risk that is out there for the economy, and it could spill over into the real estate market. And that's why I'm trying to share with you the risks that I'm seeing so that you can plan accordingly. I should mention, I am still heavily invested in the stock market, but I have, you know, made my portfolio a little bit more defensive because even though I do think a retraction is likely a correction.

51:18We just don't know the timing of that. And that's what's so hard about stock investing. I'm not going to give stock investing advice. That's not my my my expertise or my purpose of the show. But I will just say this, that even though I think that there is a correction coming, valuations might go up another 30 percent and then crash 20 percent. We just don't know. That's why I personally just take a dollar cost averaging approach to investing in the stock market and put money in at regular intervals. But I have shifted to a little bit more defensive. I want to be in the stock market in case I'm wrong and things keep going up because I'm 38 years old.

51:51And even if the market crashes, I think it will come back by the time I want to retire and maybe live off some of my stock investing. I don't want to get out of the market. I'm not panic selling or anything like that. But I am making it a little bit more defensive. I am willing to forego some potential upside to protect the downside because after all this research, I do lean a little bit pessimistic, like I said. So that's it. That's my analysis of the AI bubble potential as of right now. There are good arguments on both sides, but I'm leaning a little bit pessimistic right now just because I think there a lot has to go right almost perfectly for these valuations to be justified.

52:28And that just rarely happens. So that's how I am thinking about this and I'm going to plan my own stock and real estate investing. But I'd love to know what you think. Are we in a bubble or not? What should we as a community here at On The Market be thinking about in terms of AI? Let me know in the comments below. Thank you all so much for listening. I'm Dave Meyer. I'll see you next time.

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