HomeArtificial IntelligenceArtificial Intelligence NewsThe 1990s telecom bubble and today's AI growth share these traits

The 1990s telecom bubble and today’s AI growth share these traits

Long-term financial success for those who pioneer new technologies is not guaranteed by the stock market, which can be erratic.

Investors in the current artificial intelligence boom would do well to keep it in mind as one key takeaway from the telecom bubble of the late 1990s and early 2000s, says Jim Reid, an analyst at Deutsche Bank.

In a recent customer letter, Reid enumerated evident contrasts as well as possible parallels between the two eras.

The fact that telecom stocks never recovered to their bubble-era highs, despite the fact that smartphone penetration by 2024 exceeded even the most optimistic projections from the bubble era, is one significant nuance that Reid brought to light.

The lesson for today’s AI equities is that even with broad adoption of the technology, the high valuations achieved by the so-called Magnificent Seven and other AI plays are not justified. In the end, valuations may be even more impacted in the long run by whether or not the technology is “democratized”—that is, made into a commodity that can be readily implemented by any American enterprise.

If you were informed in 1997 that the number of cellular subscriptions worldwide would increase from 1 per 100 people to over 110 per 100 by 2024, with approximately 8 billion contracts signed, would you have predicted that telecom valuations would be steadily driven into the stratosphere? In retrospect, the answer is undoubtedly “no,” as Reid pointed out that the value of the mobile subscribers was gained elsewhere.

“Elsewhere” in this context refers to businesses that were first in the mobile internet and cloud sectors. These businesses include a number of the Magnificent Seven of today, such as Alphabet Inc., Microsoft Corp., Meta Platforms Inc., Amazon.com Inc., and, of course, Apple Inc., which transformed the smartphone market in 2007 with the release of the iPhone.

Investors were caught off guard by this commoditization in the late 1990s and by the stringent regulations that would eventually eat into the profit margins of the telecom services sector.

Some doubters of the AI stock market bubble think the Magnificent Seven will suffer a similar fate. Reid claims that they contend AI is a general-purpose technology, similar to electricity or steam engines. Because of this, the advantages will probably be shared more fairly across all businesses rather than being concentrated in a select few top organizations only because they invented the technology.

Indeed, there are a few things that separate the cutting-edge AI companies of today from the massive telecoms of the late 1990s. The most evident one, according to Reid, is that numerous telecom companies took on enormous debt loads in order to pay for the installation of fiber-optic lines and the acquisition of pricey mobile licenses.

In contrast, today’s AI darlings have far better balance sheets, and growth in free cash flow and sales has typically been accompanied by rises in capital expenditures and other spending. Additionally, their products are more valuable and have better brand identities. They also gain from a strong network effect that keeps consumers within their own ecosystems.

Additionally, although there is some overlap, according to Reid, they don’t directly compete with one another in terms of their AI businesses.

Indeed, since 1996, a lot has happened in the telecoms services industry. In 2018, the sector was folded into the newly formed S&P 500 communications-services sector.

Just three businesses are now included in the telecom services industry classification: Verizon Communications Inc., AT&T Inc., and T-Mobile US Inc.

Compared to the past, when firms like as Lucent Technologies and its rivals dominated the U.S. stock market, these companies command relatively low values.

Moreover, it is a little unfair to say that the AI boom has only benefited a small number of businesses. A group of analysts at Bespoke Investment Group recently noted that, despite the Magnificent Seven accounting for the majority of the S&P 500’s gains last year, 67 AI-linked stocks in the S&P 500 have gained 45.3% on average since the end of November 2022, when ChatGPT’s initial public release.

As U.S. markets returned on Tuesday after an extended weekend of holidays, the AI theme suffered. As investors awaited the company’s most recent quarterly earnings report, which is expected to be released on Wednesday after the bell, chip maker and AI darling Nvidia Corp. saw a decline of more than 4.3%, marking the largest daily decline since October.

The S&P 500 dropped 30.06 points, or 0.6%, to 4,975 at the close, while the tech-heavy Nasdaq Composite lost 144.87 points, or 0.9%, to 15,630.78. In the meantime, the Dow Jones Industrial Average dropped 0.2%, or 64.19 points, to 38,563.80.

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