Chip shortage and weak pass-through threaten AI rally
The artificial intelligence boom, while backed by strong cash flows, is not immune to shocks, with chip shortages posing a major risk to the ongoing rally, according to a report by Nuvama Institutional Equities. The brokerage warns that a supply shock or a sharp rise in US Federal Reserve interest rates could trigger a turning point in the AI boom, as rising chip costs and stretched valuations expose early signs of excess.
Higher hardware prices inflate capex, squeeze cash flows
Nuvama notes that higher hardware prices are inflating hyperscalers' capital expenditure and squeezing their free cash flows at a time when monetisation of AI remains limited. This could force a reassessment of investment plans as investor pressure builds. The report highlights that semiconductor prices have more than doubled year-on-year, rising about 2.5 times, which further inflates the already high capex bills of hyperscalers when the scope for passing on costs to end users is limited.
Signs of excess in AI capex and hardware stocks
The surge in AI-related capital expenditure and global hardware stocks already shows clear signs of excess, Nuvama states. These include high valuations—around 10 times price-to-book versus 2-4 times in the pre-AI era—a sharp rise in hardware tech stocks even as hyperscaler stocks stagnate, retail euphoria similar to past market peaks in 2000, 2007, and 2021, and a renewed IPO boom. The brokerage warns that a turning point in the AI boom could be triggered by a supply shock or a sharp rise in US Federal Reserve interest rates.
Weak global growth and Fed hawkishness add pressure
The report notes that the technology is still in its early stages of adoption and that global growth, excluding AI, remains weak. This will erode hyperscalers' free cash flow and invoke shareholder dissent, early signs of which are already visible. The US Federal Reserve remains hawkish, focused on price stability and its 2% inflation target, which compounds the pressure on AI investments.
Semiconductor prices double but pass-through limited
Semiconductor prices have more than doubled in the past year amid the AI boom, but passing these costs on to end users remains difficult, Nuvama notes. The vulnerability is further heightened as non-AI growth remains weak in the US and globally. Additionally, key risks to the timing of the AI mania rolling over emanate from a further supply-side easing in oil and other commodity prices.
Post-bust AI adoption expected to explode
Despite the near-term risks, Nuvama believes that after a bust in the capex mania, AI adoption will explode as costs drop dramatically. The brokerage draws a parallel to the internet era, stating, "We firmly believe that it is post a bust in the capex mania that AI adoption will explode as costs drop dramatically. This is how it has played out in the internet era and we believe this time will be no different."
