Dear Commons Community,
Mihir Desai, a professor at Harvard Business School and Harvard Law School, had a sobering guest essay in Sunday’s New York Times entitled, “I Study Financial Markets. The Nvidia Rout Is Only the Start.” It is must reading for anyone interested in high tech companies and their financial strategies in the era of artificial intelligence. He makes interesting speculations on the future of the Big Seven tech companies in light of the fiscal disaster that struck Nvidia last week in response to the announcement of China’s DeepSeek Company development of high-performance and low cost A.I. computer chips. Here is his main message.
“During last Monday’s stock market swoon, Nvidia, the artificial intelligence giant, lost nearly $600 billion in value, the biggest single-day loss for a public company on record. How could the fortunes of one of our leading companies fall so far so suddenly? While some will seek answers in the promising A.I. start-up coming out of China or the vicissitudes of trade policy, these movements speak to deeper changes in our financial markets that can best be explained, oddly enough, by revisiting ancient mythology.
The image of the ouroboros, a serpent eating its own tail, is a remarkably durable and pervasive motif. Ancient Chinese, Egyptian, European and Latin American civilizations seemed captivated by the image or ones like it, variously symbolizing the cyclic nature of life, the totality of the universe or fertility. Today, the more resonant lesson comes from the self-cannibalism of the ouroboros, which helps us understand the most significant financial puzzle of our day.
Like the ouroboros, I believe Big Tech is eating itself alive with its component companies throwing more and more cash at investments in one another that are most likely to generate less and less of a return. Monday’s correction shows that our financial markets — and possibly your retirement portfolio — may be starting to reflect an understanding of this dynamic.
Even after Monday’s dip, the disjunction in valuations between Big Tech — sometimes referred to as the Magnificent 7 of Microsoft, Apple, Amazon, Nvidia, Tesla, Meta and Alphabet — and the rest of the stock market remains staggering. The Magnificent 7 still constitute more than 30 percent of the market capitalization of the S&P 500 (up from just under 10 percent a decade ago). When you compare their stock prices with their earnings or sales, the traditional way to measure the valuation of a share, our tech Goliaths trade at ratios that are two to three times those of the Unmagnificent 493.
Market watchers have debated whether Big Tech stocks will continue to outperform everyone else or if shares in other companies will catch up as they use artificial intelligence to become more productive. But the myth of the ouroboros suggests yet another possible outcome.
The first step in understanding this analogy is to return to some finance basics. Stock prices don’t always rise because the prospects of companies improve. They also rise when investors judge certain companies to be a safer bet than others and don’t penalize them for taking longer to generate returns for their money.
While many industry watchers have argued that artificial intelligence will cause the fortunes of the Magnificent 7 to soar, another dynamic is at play: Investors see these companies as a safe bet and have thus stopped demanding significant immediate returns. That’s why the earnings forecasts of stock analysts have not kept pace with the skyrocketing stock prices of these companies.
Why wouldn’t investors expect more for their investment dollars?
I believe global investors have come to see the equities of these seven companies as the premier safe assets. In a world of inflationary spikes, political instability and gridlock and fiscal uncertainty, why not invest in companies with fortress balance sheets, recurring revenue, stable cash flows, commanding market positions and esteemed management teams? It seems a new generation of investors implicitly views these companies almost like governments. Indeed, as evidenced by Tesla’s extraordinary valuation, it’s clear its founder Elon Musk has inspired a loyalty that is akin to a sovereign. In a world of algorithmic trading and passive investing, those beliefs take on a velocity that results in the extremely high prices for Big Tech stocks we see today.
How have the managers of these companies responded to this massive influx of cheap money? Perhaps, precisely as they should have, by pouring more and more capital into investments without worrying about expecting a lot back quickly. From a practical standpoint, what they seem to have done is unleash a remarkable torrent of spending on one another. In other words, they are eating themselves alive.
Nvidia, the much-beloved creator of the next generation of A.I. chips whose stock was crushed on Monday, gets almost half of its revenue from its siblings in the Magnificent 7. In 2022, Google paid Apple $20 billion for the privilege of being the default search engine on Safari, according to unsealed court documents, and therefore very likely accounts for around 20 percent of Apple’s profit. Meta employs Amazon Web Services for cloud services and increasingly in its A.I. push, and all of the tech giants have unleashed an inordinate amount of spending on infrastructure.
And when the tech giants aren’t showering money on one another, they often practice another form of self-cannibalism: purchasing their own shares. In the past three fiscal years, Apple, Alphabet, Meta, Microsoft and Nvidia have bought back a total of over $600 billion of their own stock — a notoriously low-return activity.
There is nothing particularly troubling about the Magnificent 7 purchasing products and services from one another. Nor is there anything necessarily wrong with spending large amounts on capital expenditures or stock buybacks. But if all of these operational and capital allocation decisions are guided by extremely low investor expectations, they may well eventually yield correspondingly low returns. And that gives us a possible glimpse into what lies ahead for the Magnificent 7 and A.I. Rather than a boom that expands still further to a speculative bubble or a rally for the remaining Unmagnificent 493, we may just witness a slow grind of low returns on excessive spending on a technological future that will not be nearly as revolutionary or imminent as promised.
More dangerously, these companies — like all companies — will one day disappoint those who view them as safe assets. And the self-cannibalization will reveal itself to be not just a mediocre investment but also a shaky bet on an illusion propagated by a mythical and messianic belief in technology and these companies.
Similar dynamics have shaped other periods in American history. The remarkable expansion of railroads in the 19th century gave rise to similarly magical thinking; by the early 1900s, after a few decades of frenzied investment, the rail industry made up more than 60 percent of equity market capitalization, and its bonds were considered a safe bet. Their low yields fueled spending on steel and, ultimately, gave rise to the creation of the huge conglomerate U.S. Steel in 1901.
What followed in the first two decades of the 20th century? Remarkably low profits from these companies and mediocre returns from the stock market overall. The natural limits on railroads and entrenched steel players soon became evident, as did the organizational problems that go along with such scale.
Of course, the natural physical bounds that limited the growth of America’s railroads may not exist for today’s Magnificent 7. If artificial intelligence is a truly general purpose technology, then it may well have far greater potential. That said, information technology has been promising such productivity growth for the last two decades without delivering.
One need not look at ancient folklore to find depictions of the ouroboros. The economist Joseph Schumpeter once described capitalism as a process of almost mystical renewal. He admiringly wrote of a cycle of industrial mutation “that incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” That process of creative destruction sounds just like an ouroboros — but that image is easier to admire and appreciate if it’s not your own tail that’s being eaten.”
Thank you Dr. Desai for a most interesting analysis!
Tony
