Analysis: As the AI Boom Rages, Investors Grow Wary of Potential Derailments

The rise of the US stock market to new highs is being dominated overwhelmingly by enthusiasm over the profit prospects of Artificial Intelligence (AI). Since the launch of ChatGPT in late 2022, AI has become the dominant theme on Wall Street, with Citigroup strategists estimating that nearly 50% of the S&P 500's massive $57 trillion market capitalization has significant exposure to the technology. This enthusiasm is reflected in the indices' performance, with the S&P  up about 13% and the tech-heavy Nasdaq climbing 17% year-to-date.

But under this tide of euphoria, investors are also becoming increasingly cautious, actively on the lookout for vulnerabilities that can crash the high-flying "AI trade." Although the long-term potential is generally recognized as huge, the main fear is that the market has already bid in an abnormal level of future growth and therefore risks disappointment.

Investors and strategists have pointed to several risks that can upset the AI rally:
1. Unsustainable Capital Expenditure (Capex):** The first and most obvious fear is the enormous amounts of capital that need to be spent on constructing AI infrastructure. Large technology "hyperscalers" such as Microsoft, Amazon, Alphabet, Meta, and Oracle are forecast to have their annual capex double to $500 billion by 2027. The key is if these huge expenditures will come back with a big enough return on investment. Investors are watching closely if this spending will start to cut into companies' profitability and free cash flow margins. An unexpected deceleration in this expenditure could also be negative, indicating a loss of confidence in demand in the future.

2. Systemic Risk Due to "Circular" Transactions:" The development of complicated financial links in the AI marketplace is causing concern. Prominent transactions, like Nvidia's proposed investment in OpenAI, form a web of interconnected firms. Not necessarily "sinister" in nature, these intimate money and business connections focus risk. Should one such critical participant falter, there can be a domino effect across the entire AI industry.

3. The Energy Bottleneck: One major physical limit on the AI boom is power availability. Barclays strategists have pointed out that the current energy infrastructure could turn out to be inadequate to accommodate the vast build-out of data centers. The "power problem" is cited as one of the most essential "gating factors" that might stop the AI expansion in its tracks.

4. Unsubstantiated Returns and Fading Demand:** At the end of the day, the whole AI thesis hangs on the technology delivering real revenue and productivity benefits. To date, proof of these hoped-for returns has been lacking. Shareholders are on the lookout for any hint that demand for AI services is fading away or that the technology is not coming anywhere close to fulfilling its revolutionary hype. If, however, it becomes evident that the investments of hundreds of billions of dollars will not yield as they had promised, the confidence in the market would evaporate very fast.

In summary, as the AI revolution has driven the market to record highs and its long-term value is to a great extent not in dispute, the journey ahead is bumpy. The valuation of the market presently relies on near-flawless execution and mega returns. When the companies start to report results, investors will be looking for any clues that the AI gravy train is to experience any of these possible derailments.