When the curtain closes on 2024 in less than two weeks, it will likely represent another banner year for Wall Street. The iconic Dow Jones Industrial Averagebenchmark S&P 500and powered by growth Nasdaq Composite each has soared to multiple record-breaking highs this year.
While there has been a confluence of factors lifting Wall Street's major indexes into uncharted territory, including better-than-expected corporate earnings, stock split euphoria, and Donald Trump's victory in Novembernothing creates more excitement than the artificial intelligence (AI) revolution.
The long-term addressable market for AI is almost limitless. AI-empowered software and systems can become more proficient at their assigned tasks, and can evolve and “learn” without human intervention. That's why PwC analysts estimate that AI will add $15.7 trillion to the global economy by the turn of the decade.
In response to this generational opportunity, top-tier AI stocks have soared—and with good reason.
Wall Street's massive AI rally may end in 2025. Image source: Getty Images.
Nvidia (NASDAQ: NVDA) has gained nearly $2.9 trillion in market value since the start of 2023, with the company's graphics processing units (GPUs) becoming the undisputed top choice in AI-accelerated data centers. Last week, AI networking solutions specialist Broadcom It became only the 11th publicly traded company globally to reach a nominal valuation of $1 trillion. Meanwhile, an AI-driven data mining expert Palantir Technologies (NASDAQ: PLTR) is picking up on the heels of a 1,000% gain over the two-year trailing period.
These represent just a few of the prominent Wall Street tech stocks that have surged significantly on the expectation that demand for AI hardware and software will change the corporate landscape.
But while Nvidia and Broadcom's growth forecasts have knocked even the highest analysts' expectations out of the park, there are reasons to believe that the artificial intelligence bubble will burst in the new year.
Among the catalysts that could halt the near-parabolic climb that AI stocks like Nvidia and Palantir have enjoyed, none stand out more than history. While history is not a timing tool, it does have a great track record of predicting eventual setbacks in market-leading businesses at the forefront of the next big thing's innovations.
About 30 years ago, the internet started to go mainstream and changed the arc of corporate growth positively forever. However, businesses had not fully understood the usefulness of the internet for many years, which is why we saw the dot-com bubble develop.
Since the advent of the internet, we have witnessed many next big thing technologies, innovations and trends, including genome decoding, 3D printing, blockchain technology, cannabis, and the metaverse. The problem is that they all suffered a blistering event in its early stages.
Without fail, professional and everyday investors have consistently overestimated how quickly a new technology or innovation would be adopted and used. This ultimately leads to the disappointment that causes the market leaders of these next-big trends to lose 80% to 99% of their value.
To be clear, I am in no way suggesting that AI cannot be a game-changing technology. What I am saying is that all new technologies and innovations need time to mature. The simple fact that most businesses cannot lay out a clear plan for how they will use AI to generate a positive return on their investment is a pretty good indicator that we are in a bubble.
Another reason the AI bubble may burst in 2025 is the expected resolution of the GPU shortage that has sent Nvidia stock into the stratosphere.
Demand for Nvidia's hardware has been otherworldly, with orders for its H100 GPU, commonly known as the “Hopper,” and its Blackwell GPU successor backlogged. When the demand for a good or service exceeds its supply, it is normal for its price to climb. Earlier this year, Nvidia was claiming around $40,000 for its Hopper chip, a premium of up to 300% to what Advanced Micro Devices netting about its Insight MI300X GPUs.
In other words, Nvidia has been able to use AI-GPU scarcity to its advantage to increase the price point of its hardware and pump its gross margin into the mid-70% range.
However, I fully expect this scarcity advantage to fade in the new year. AMD is rapidly increasing its chip production and recently introduced its next-generation MI325X GPU.
In addition, many of Nvidia's top customers by net sales are developing AI-GPUs in-house for use in their data centers. While Nvidia's chips should remain superior from a computing perspective, these in-house developed GPUs will be much cheaper and easier to access. It's a recipe for Nvidia to lose valuable data center real estate, and for its pricing power and margin to decline.
Image source: Getty Images.
Aside from history not being on the side of the AI revolution, the AI rally could also be spent due to the actions taken by US regulators.
In 2022 and 2023, regulators under the Biden administration announced a restriction on the export of powerful AI chips and chip-related manufacturing equipment to China. This affects leading hardware manufacturers such as Nvidia, as well as the company that provides the tools to produce AI solutions. For example, a semiconductor wafer fabrication equipment company Lam Research it generated 37% of its revenue from China during the quarter ending in September, and 39% in the quarter before that.
Under President-Elect Donald Trump, it is unlikely that we will see these restrictions eased or lifted. Trump took a tough stance on the world's No.2 economy during his first term as president, and this is likely to continue when he takes office on January 20.
To add, Trump has decided that he would impose a 35% tariff on imports into the United States from China on Day One. More than likely, this is going to trigger a trade war that strains trade relations between the world's two largest economies and adversely affects sales of AI products to China.
The final reason the AI bubble will burst in 2025 has to do with unsustainable historical valuation premiums currently being assigned to market-leading AI stocks.
Over the past 30 years, businesses that are at the forefront of the next big thing's innovations have often managed to achieve a 30 to 40 times sales volume within 12 months. This is a place Amazon a Cisco Systems peaked before the dot-com bubble burst.
In 2024, we've seen Nvidia peak at a price-to-sales ratio (P/S ratio) of more than 40, while Palantir Technologies is currently pushing a P/S ratio of nearly 69. Although it's impossible predict when investor euphoria fades, history has been abundantly clear that extended valuations of this magnitude are not sustainable in the long term.
While businesses with sustained moats, such as Nvidia and Palantir, deserve a premium valuation, relative to their peers, price-to-sales ratios of 29 for Nvidia and nearly 69 for Palantir make no sense.
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John Mackey, former CEO of Amazon subsidiary Whole Foods Market, is a member of The Motley Fool's board of directors. Sean Williams He has jobs at Amazon. The Motley Fool has positions in and recommends Advanced Micro Devices, Amazon, Cisco Systems, Lam Research, Nvidia, and Palantir Technologies. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.
