The artificial intelligence (AI) sector, which has been one of the hottest areas of the stock market in 2023, is facing a reality check as investors grow skeptical about the technology’s long-term prospects. Several AI stocks have entered correction territory, meaning they have fallen more than 10% from their recent highs, as the market shifts its focus to other themes and sectors.
AI hype fades amid rising interest rates and inflation
One of the main reasons for the AI stocks’ decline is the rising interest rates and inflation in the US, which have dampened the appetite for high-growth tech stocks. The Federal Reserve has hiked its benchmark rate by 500 basis points since early 2022 to contain inflation that hit 40-year highs last summer. Higher borrowing costs tend to reduce demand and pull down asset prices.
AI stocks are particularly sensitive to changes in the price of money, as they are valued based on their expected future cash flows. Higher discount rates lower the present value of these cash flows, making them less attractive to investors. Moreover, AI stocks often trade at high multiples of their earnings or revenues, reflecting their growth potential. However, this also means they have more room to fall if their growth prospects dim.
Some analysts have warned that the AI sector could be entering a hype cycle, where expectations exceed reality and lead to disappointment. According to Amara’s Law, we tend to overestimate the effect of a technology in the short run and underestimate the effect in the long run. This means that AI stocks could face a period of underperformance before they realize their full potential.
AI leaders face increased competition and regulatory scrutiny
Another factor that has weighed on the AI stocks is the increased competition and regulatory scrutiny that they face. The AI sector is dominated by a few large players, such as Nvidia, Microsoft, Alphabet, and Amazon, which have invested heavily in developing and acquiring AI technologies and talent. These companies have benefited from the network effects and economies of scale that come with being market leaders.
However, they also face challenges from new entrants and rivals that are trying to catch up or disrupt their businesses. For example, AMD and TSMC are competing with Nvidia in the chip market, while Salesforce and Oracle are challenging Microsoft and Alphabet in the cloud computing space. Additionally, some smaller and more specialized AI companies, such as C3.ai and Okta, are carving out niches in specific domains or applications.
Furthermore, the AI leaders are also under pressure from regulators and lawmakers who are concerned about the ethical and social implications of their technologies. Issues such as data privacy, bias, accountability, and transparency have become more prominent as AI becomes more pervasive and powerful. The AI sector could face more regulation and litigation in the future, which could limit its growth and innovation.
AI stocks still have long-term potential despite short-term volatility
Despite the recent slump, some investors and analysts remain optimistic about the long-term potential of the AI sector. They argue that AI is still in its early stages of development and adoption, and that it will continue to transform various industries and sectors in the future. They also point out that AI stocks have shown resilience and strength in the past, bouncing back from previous corrections and downturns.
According to a report by Grand View Research, the global AI market size was valued at $62.4 billion in 2020 and is expected to grow at a compound annual growth rate (CAGR) of 40.2% from 2021 to 20281. The report cites factors such as increasing demand for smart devices and systems, rising adoption of cloud-based services and applications, growing investments in research and development, and improving computing power and speed as drivers of the market growth.
The report also identifies some of the key segments and applications of the AI market, such as natural language processing (NLP), computer vision (CV), machine learning (ML), deep learning (DL), speech recognition (SR), image recognition (IR), chatbots (CB), robotics (RB), self-driving cars (SDC), healthcare (HC), e-commerce (EC), cybersecurity (CS), gaming (GM), social media (SM), and education (ED). These segments and applications offer various opportunities for innovation and differentiation for both existing and new players in the AI sector.
Therefore, while AI stocks may face some headwinds and volatility in the short term, they still have a lot of potential and value in the long term. Investors who are interested in this sector should do their due diligence and research before buying or selling any AI stocks. They should also diversify their portfolio across different segments and applications of the AI market, as well as across different regions and markets.