Artificial Intelligence Frenzy: Goldman Sachs and Morgan Stanley Diverge on Bubble Risk

The extent of human influence on artificial intelligence is not yet fully clear.

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The recent Morgan Stanley report on Microsoft's "AI monetization" highlights market concerns about the company's ability to capitalize on artificial intelligence investments. Despite Microsoft's stock underperforming tech peers over the past quarter, Morgan Stanley believes the market is underestimating the mid-term prospects for AI revenue growth.

The report projects Microsoft's total capital expenditures will nearly double from $32 billion in fiscal 2023 to $63 billion in fiscal 2025. However, AI revenue is forecast to grow from $5.8-9.6 billion in fiscal 2024 to $46.5-77.4 billion by fiscal 2027. Morgan Stanley expresses confidence that core IT spending will drive commercial returns for Microsoft's AI business.

Not all analysts share this optimistic outlook on AI monetization. A recent Goldman Sachs report notes that major tech companies have invested approximately $357 billion in capital expenditures and R&D over the past year, with a significant portion directed towards AI. However, the report cautions that these companies will need to demonstrate that these investments can generate revenue and profits to justify their valuations.

According to The Information, despite Microsoft's large Office 365 customer base and claims that 60% of Fortune 500 companies are paying for its Copilot AI assistant, this market advantage has yet to materialize in financial results. Office application enterprise sales growth actually slowed by 2 percentage points from Q4 2023 to Q1 2024. Even optimistic analysts estimate Microsoft will only generate about $10 billion from AI this year.

A recent business magazine article concluded that AI technology has produced little economic benefit so far. The five major tech giants - Alphabet, Amazon, Apple, Meta and Microsoft - are expected to invest about $400 billion in AI capital expenditures in 2024. This has fueled investor optimism, adding $2 trillion to these companies' market capitalizations. However, realizing significant AI revenue remains a long-term prospect.

Bill Gates recently commented that the level of capital flooding into AI is unprecedented, with market valuations and enthusiasm surpassing previous tech booms like the internet and automobile eras.

The "Magnificent Seven" tech stocks - Apple, Microsoft, Alphabet, Amazon, Nvidia, Tesla, and Meta - now account for 27.9% of the S&P 500 index. Their strong performance, driven by AI optimism, has pushed the S&P 500 up over 15% this year. Some analysts predict the index could reach 7,000 by 2025 due to AI enthusiasm.

However, this rapid growth is reminiscent of the dot-com bubble for some market veterans. Goldman Sachs has cautioned that companies will need to demonstrate that AI investments can generate revenue and profits.

AI development requires massive spending even for cash-rich tech giants. Meta reportedly spent $30 billion on GPUs, exceeding the cost of the Apollo moon landing program (adjusted for inflation). In Q2 earnings, Meta increased its 2024 capital expenditure guidance to $35-40 billion.

Goldman Sachs estimates that Amazon, Meta, Microsoft and Google have invested $357 billion in capital expenditures and R&D over the past year, with a large portion going to AI. This represents nearly a quarter of total S&P 500 capex and R&D spending.

Companies fear falling behind in AI and are willing to invest heavily in future potential. Some estimates suggest Silicon Valley could spend $1 trillion on AI capital expenditures in coming years. However, there is little concrete evidence yet that these investments will pay off. Even industry leader Microsoft is only expected to generate up to $10 billion in AI revenue this year.

Goldman Sachs warns of potential "overinvestment" in AI. Their index tracking companies expected to benefit most from AI-driven productivity gains has not outperformed the S&P 500 since late 2022, suggesting investors are not seeing prospects for additional profits.

So far, Nvidia has been the clear financial winner from the AI boom, with surging demand for its GPUs. Goldman Sachs expects AI infrastructure providers in semiconductors, data centers, and cloud services to be the next beneficiaries of AI investment. AI security companies may also emerge as winners.

IT service companies leveraging AI capabilities are predicted to benefit in later stages as the technology becomes more widely adopted across industries. Companies in specific sectors could see significant profit growth potential as AI enhances productivity.

The AI infrastructure space is becoming crowded, with major tech companies competing as both customers and providers. Each hopes their investments will yield better returns than competitors.

The real-world impact of AI remains uncertain. While some Goldman Sachs economists project AI could boost productivity by 9% and GDP by 6.1%, current adoption rates are low. A U.S. Census Bureau report found only 5% of U.S. businesses are using AI, expected to rise to 6.6% in Q3.

AI's ability to replace human workers in many scenarios is still limited. Most people would likely prefer interacting with a human over an AI system for complex queries. Humans can better assess situations in real-time and respond accordingly, while AI responses are based on historical data and lack true situational awareness.

Some argue tech giants are overstating AI's capabilities and ignoring the complexity of human interactions. Companies like Walmart and McDonald's have reportedly been dissatisfied with AI implementations for customer service.

For individual users, AI services remain largely novelties with low willingness to pay. While early optimism suggested AI would free humans from mundane tasks, increasing concerns about job displacement have emerged as applications become more specific.

Scholars question whether the $1 trillion invested in AI will translate to real productivity gains. Some estimate only 23% of production tasks could be automated through AI economics in the next decade, saving an average of 27% in labor costs. MIT professor Daron Acemoglu projects AI will only boost economic productivity by about 0.5% and GDP by 1%.

If AI's benefits are limited to efficiency gains rather than enabling new productive activities, the economic impact may be muted. Replacing cost-effective human labor with expensive technology may not make business sense in many cases.

Goldman Sachs estimates 7% of the workforce could face unemployment risk from AI. Government intervention may occur if AI adoption exacerbates social tensions.

However, the full economic impact of AI likely remains to be seen. Its potential to reshape the economy and job market is still uncertain.

What is clear is that the AI arms race shows no signs of slowing. Based on historical returns, the $1 trillion invested in AI would need to generate $310 billion in revenue to match past tech investments.

As the company with the most robust AI business model currently, Nvidia's data center revenue reached $47.5 billion in 2023. This suggests the industry-wide revenue target is achievable, but realizing it will require continued innovation and successful commercialization of AI technologies across sectors.