AI’s creative destruction or benign reset?
Ed Yardeni just published his latest research note titled “Is AI useless?”
Now, to be fair, questioning whether trillion-dollar hyperscalers, NVIDIA and Frontier Labs, are collectively making an AI-powered mistake is clearly motivated by a little attention-seeking, but AI leaders are facing real challenges.
The primary challenge is, of course, a financial one. Macroeconomic headwinds, bond market pressures, and capital liquidity are prompting investors to question the artifivcal intelligence (AI) narrative and its implications for the market’s long-term trajectory.
For the last two years, big tech’s AI narrative has been running on pure momentum. Eventually, however, all general-purpose technologies have to answer to the arbiters of long-term returns: cost of capital and net income.
It’s fair to say investors aren’t nervous about what large language model (LLMs) and AI agents can achieve, but they are increasingly worried about the sheer expense of running them. Indeed, Yardeni go so far as to describe AI as confronting a “potentially toxic trifecta of financial constraints”, each of which we’ve discussed here previously.
The first is rising, and now elevated, borrowing costs.
The ultra-low interest rates that fueled the last decade’s tech expansion are over. The 10-year Treasury yield has recently hovered near the top of its former range of 4.0 per cent to 5.0 per cent – and at its highest since 2007. Higher risk-free rates automatically lower the present value of future earnings. When borrowing costs five per cent instead of one per cent, funding speculative, long-dated technology buildouts becomes a whole lot more expensive unless strong earnings growth offsets the higher rates.
At the same time, Wall Street is growing impatient, as it inevitably does, that there’s no clear path to attractive profitability on the tens of billions of dollars per quarter hyperscalers are spending on data centres, custom silicon, and energy infrastructure.
Meanwhile, when every major technology enterprise tries to spend heavily on identical infrastructure at the same time, capital availability and risk appetite become stretched. Most recently, investors are questioning whether total market liquidity is sufficient to finance everyone’s ambitious, overlapping AI roadmaps without starving other business segments.
The second material issue is reflected by widening credit spreads
The way equity investors express scepticism is by selling shares. In the fixed-income market, credit default spreads widen, especially for heavily indebted or aggressively spending AI borrowers.
When credit spreads widen, bond market investors demand higher yields to hold a company’s debt, reflecting greater concern about credit quality and leverage. Bondholders care deeply about cash coverage. If a company aggressively borrows to buy GPUs and build data centres before establishing clear, recurring revenue from those assets, the bond market flags it as added leverage risk.
The result is a feedback loop that ultimately results in something equity investors care deeply about: a hyperscaler blinking on its buildout.
Higher bond yields raise total borrowing costs. Higher financing costs lower projected returns, and lower anticipated return on investment (ROI) forces management teams to pare back CapEx plans. Someone blinks.
The “Roaring 2020s” thesis
Yardeni, however, is one of the more bullish analysts on Wall Street today. His ‘Roaring 2020’s’ thesis is based on the idea that a surge in AI-driven productivity growth will keep inflation in check, boost corporate profit margins, and drive real wage growth.
According to Yardeni, history shows that every major transformational technology – from steam engines and railways to the internet – follows a similar curve, which begins with an Initial Euphoric phase, followed by a Financial Digestion period, and ultimately the Utility Phase.
Following the invention of the technology, hype-fuelled expectations lead to massive capital investment. This is followed by rising interest rates, debt friction, and valuation resets, which force companies to focus on efficiency rather than pure expansion. We’re in this phase now. When the hype settles, costs fall, and real, widespread productivity gains emerge across sectors.
Yardeni’s assessment of historical General Purpose Technology timelines, however, fails to acknowledge that many went through a period of Creative Destruction. This phase causes many players to go bankrupt, costing investors billions, before distressed asset buyers pick up IP cheaply, allowing them to distribute the technology affordably and drive broad adoption.
Conclusion
We can agree with Yardeni that AI is not a technological dead end.
We can also agree the current environment represents a necessary financial discipline phase.
What we cannot agree on is whether this phase is a benign reset or the beginning of a Creative Destruction phase.
Higher interest rates and widening credit spreads force corporate leaders to move away from vanity projects and focus on high-margin, practical applications of artificial intelligence that generate immediate business utility.
If they exist today, we’ll be fine. If they don’t, watch out below.
Yardeni has been bullish all year, and he may be right. He’s certainly defending his thesis frequently when markets stumble. I agree AI definitely isn’t useless. But is it just growing up and leaving its cost-free capital honeymoon behind, as Yardeni suggests, or is this the start of something more painful?
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
He is also author of best-selling investment guide-book for the stock market, Value.able – how to value the best stocks and buy them for less than they are worth.
Roger appears regularly on television and radio, and in the press, including ABC radio and TV, The Australian and Ausbiz. View upcoming media appearances.
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