The AI Bubble Falters: Can The Fed Save It?
The AI Bubble Falters: Can The Fed Save It?
Rapid rate cuts are no silver bullet
Stock markets are crashing, with AI high-flyers leading the way. NVIDIA is now down about 22% from its all-time highs.
Even after the pullback, NVIDIA NVDA 0.00%↑ shares are still up 2,667% over the last 5 years (as of 8/7/24). If you still have significant long-term gains in NVDA or any other hot stock, it may still be a good time to take some profits.
NVIDIA’s meteoric rise has drawn comparisons to Cisco’s performance during the dot-com bubble which popped in 2000. Here’s a chart from Deutsche Bank, via CNBC’s Brian Sullivan, as of 7/31/2024.
From its IPO, Cisco rose about 1,600x ($.05 split-adjusted IPO price → $80 high) at its peak. NVIDIA, meanwhile is up about 2,525x from its split-adjusted IPO price of $.04. It’s noteworthy that Cisco stock, 24 years later, has not recovered to its 2000 ATH.
There is zero doubt that NVIDIA is one of the last great founder-led tech companies. But as I pointed out back on 7/23, its valuation, then trading at 36x sales, was and is stretched. Cisco peaked at a similar price/sales ratio of 39x (though it had a far higher P/E, at over 190x, compared with NVIDIA’s 61x).
Pressure Grows for Fed Rate Cuts
JPMorgan chief economist Michael Feroli recently said the Fed was "materially behind the curve,” and that there was a "strong case to act before September,”. Markets are now pricing in .50% cuts in September and November.
So, could rapid rate cuts prevent the bubble from bursting? Let’s look at a time period with some similarities.
In 1998, towards the tail end of that tech bubble, the Federal Reserve cut rates 3 times by 25 basis points for a total cut of 0.75%. At the time, the world was reeling from the Asian financial crisis, Russia’s default, and the resulting implosion of hedge fund Long-Term Capital Management (LTCM).
The ‘98 rate cuts reinvigorated US tech markets, with the Nasdaq index soaring from around 1500 to over 5000 at its peak in March of 2000. A huge portion of the dot-com bubble gains occurred in this last 18 months.
If the Fed cuts rates in the very near future, we could see a substantial bounce. Shares could even surpass previous ATHs.
Then again, we may have already had our 1998-esque moment in the massive rate cuts during the pandemic. So it’s possible we’re closer to a bubble peak.
My view is that the Fed will inevitably have to have to start a huge new round of QE, and probably cut rates to near zero again. The debt service problem is spiraling with rates this high, and the risk of an economic collapse is growing. But this won’t necessarily save markets.
In January of 2001, the Federal Reserve cut rates aggressively. But markets collapsed alongside them.
Rate cuts are far from a silver bullet. Once a bubble starts to burst, it’s difficult for anything, even drastic central bank action, to stop it.
Disclosure: I have no positions in any companies mentioned in this article and no relationships with any companies mentioned.