
February 2, 2025
The current speculative episode in Artificial Intelligence (AI) has many parallels with the first Dot.Com bubble in 1999/2000. As Soros said on bubbles, “financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times, it is quite pronounced. When there is a significant divergence between market prices and the underlying reality, there is a lack of equilibrium conditions.”
“Every bubble has two components: an underlying trend that prevails and a misconception relating to that trend. When a positive feedback loop develops between the trend and the misconception, it sets a boom-bust process in motion. The process is liable to be tested by negative feedback along the way. If it is strong enough to survive these tests, it reinforces both the trend and the misconception.”
A subtle but important point above is that there is often fundamental support for a speculative mania. That reinforces the trend (consensus beliefs) and the misconception of reality. It also encourages speculators to buy an asset on the hope that it will be worth more in the future. As we noted last year, enthusiasm for artificial intelligence (like the internet bubble in the 2000) is warranted regarding its potential to improve productivity in a range of industries.
However, the developments over the past week (post Deep Seek) have clearly posed a question over future trend returns in the sector. Our big picture (non-specialist) conclusions are 1) AI gets cheaper, 2) AI requires less power than previously thought, 3) AI proliferates faster, 4) AI winners aren’t who we thought and 5) existing capital spending outlays might be very wrong.
In 2024, we argued that the euphoric speculative feedback loop could push valuation multiples well beyond what seemed remotely plausible. The MSCI USA Information Technology sector now trades at 9.5 times sales or well above the 2000 and 2021 peak of 8 times sales (chart 1). We also argued that if returns on capital and profit margins are high (NVDIA’s gross margin is 80%) other companies will enter the market to compete. That is how capitalism works. The development this week is that competition has arrived for Open AI from several sources. Although the impact on NVIDIA is more complex – does the increased adoption raise demand for semiconductor chips?
Chart 1

The complexity for markets more broadly is that the consensus belief in American exceptionalism and the mega-cap technology sector has become extremely crowded. That is evident in performance, positioning, and valuation. Our sense is that there is also a strong recency bias. Market participants are not evaluating the economic cycle and regime shift particularly well as most historical models and analysis tend to be cyclical or mean-reverting in nature.
What we do know is that US equities, especially mega-cap technology, has very heroic growth and profit margin assumptions that are vulnerable to disappointment relative to beliefs. In contrast, valuations, positioning, expectations, and beliefs are the opposite for Chinese technology. We don’t know if the Alibaba AI model is superior, or if they can monetise the platform, but the stock trades on 10 times earnings, net cash on balance sheet and is buying back shares. It has rallied handsomely over the past week on the ADRs listed in the USA.
The other major prevailing bias in markets is the higher path of inflation and interest rates under the new US Administration amplified by fear over tariffs. We note that the path for the Fed funds rate implied by the markets is around 100 basis points higher for December 2025 compared to what was priced in September 2024. Our sense is that this might be too high if the Administration is successful in reducing the fiscal impulse.
According to Elon Musk, the administration is on target to reach the $4 billion per day required to reduce deficit from $2 trillion to $1 trillion in FY2026. That would be quite an achievement if true and a large reduction in the fiscal thrust. As we also noted recently, US real rates are already high by historical standards and have reached the level where they will likely tighten financial conditions and moderate growth with a lag over the coming months.
The big picture point is that the markets might be too aggressive on the path of rates and US dollar strength (which is also a crowded position and prevailing bias). We fear that the magnitude and speed of the rise in real rates has probably reached the point where it will have consequences for equity valuation and potential explosive moves in volatility. The good news is that this might ease interest rate and US dollar pressure on EM and Asia.
Comments