AI Investment Risks: What Could Derail The Technology Bull Market On Wall Street

Technology and AI-linked stocks have experienced several setbacks this year. (Representational)

New York:

The remarkable optimism surrounding artificial intelligence's profit potential has propelled US stock markets to historic highs, but investors are increasingly scrutinizing potential vulnerabilities in the AI investment landscape and identifying key risk factors to monitor.

Since ChatGPT's launch in November 2022, AI has dominated Wall Street conversations by generating enthusiasm about the technology's capabilities. According to Citigroup strategists, approximately 50 percent of the S&P 500's massive $57 trillion market capitalization has either "high" or "medium" exposure to artificial intelligence.

The benchmark index has gained about 13 percent year-to-date, while the technology-focused Nasdaq Composite has surged 17 percent.

"A significant portion of what's sustaining the markets is either directly or indirectly connected to the AI trade," explained Yung-Yu Ma, chief investment strategist at PNC Financial Services Group.

Technology and AI-related stocks have faced multiple challenges throughout the year. Earlier this year, the emergence of Deepseek, a low-cost Chinese AI model, sent reverberations through technology stocks by raising concerns about excessive capital expenditure. Similar questions surfaced again in August, temporarily affecting tech stocks once more. Despite these challenges, the AI investment thesis has recovered and continued to flourish.

"There's an enormous opportunity here, but it ultimately comes down to what's already priced in versus what isn't," said Steve Lowe, chief investment strategist at Thrivent Financial. "Considerable growth is already factored into valuations, which raises concerns because numerous risks could potentially undermine current expectations."

While some market participants highlighting these risks remain optimistic as the S&P 500 enters the fourth year of its bull market run, investors have identified potential warning signs to watch for as technology companies and other major US corporations begin reporting their quarterly results in the coming days.

Massive Capital Expenditure Under Scrutiny

Given the enormous capital investments required to develop infrastructure supporting AI applications, investors indicated they will closely monitor spending rates, return on investments, and the potential for these outlays to diminish profitability.

According to Barclays strategists, capital expenditure from major cloud computing and AI platform companies known as "hyperscalers" – including Microsoft, Amazon, Alphabet, Meta Platforms, and Oracle – is expected to approximately double from 2024 to 2027, reaching $500 billion annually.

While these companies generate substantial cash flows, it's crucial to observe whether they are "spending faster than their growth rates and eroding their free cash flow margins," cautioned Michael Arone, chief investment strategist for State Street Investment Management.

Investors are also concerned about any unexpected reduction in spending, given the importance of technology outlays in supporting AI expansion.

"The greater risk isn't excessive investment; it's insufficient investment at this juncture," stated Garrett Melson, portfolio strategist at Natixis Investment Managers Solutions.

There could be implications from potential "circular" deals involving AI companies with overlapping interests, such as Nvidia's recent announcement of plans to invest up to $100 billion in OpenAI.

While the interdependent relationships within the AI ecosystem "don't appear nefarious... there is significant systemic risk in such close financial and operational connections," Irene Tunkel, chief US equity strategist at BCA Research, noted this week.

Technology companies possess substantial cash reserves to support AI spending and strategic transactions. However, a shift toward increased leverage might raise concerns.

"When these major announcements occur, investors prefer to see funding through cash flow rather than debt or equity issuances," explained Anastacio Teodoro, senior portfolio manager at Federated Hermes.

Monitoring Return On Investments

Barclays strategists remain positive about the AI theme over the next 12-18 months but are wary that energy infrastructure may prove insufficient to support data centers and AI-related development.

"The power issue likely represents one of the most critical limiting factors to monitor," Venu Krishna, head of US equity strategy at Barclays, stated during a recent media briefing.

Investors are also vigilant for signals that demand is diminishing or that substantial investments aren't yielding anticipated returns.

"One potential trigger would be if requirements suddenly appear likely to be less than originally projected," PNC's Ma observed.

Patrick Ryan, chief investment strategist at Madison Investments, noted there haven't yet been many concrete indications of significant revenue and productivity improvements resulting from AI.

"If questions arise regarding whether all this investment will truly deliver returns... that scenario would present considerable risk," Ryan remarked.

"How that might unfold, I cannot precisely predict."