Deutsche Bank on ‘the summer AI turned ugly’: markets are ‘more sober’ than the dotcom bubble, but with troubling data-center math

AI hype and market volatility

Those data centers, though

Echoes of prior bubbles

Nick Lichtenberg is Fortune Intelligence editor and was formerly Fortune's executive editor of global news.

Deutsche Bank analysts have been watching Amazon Prime, it seems. Specifically, the “breakout” show of the summer, “The Summer I Turned Pretty.” In the AI sphere, analysts Adrian Cox and Stefan Abrudan wrote, it was the summer AI “turned ugly,” with several emerging themes that will set the course for the final quarter of the year. Paramount among them: The rising fear over whether AI has driven Big Tech stocks into the kind of frothy territory that precedes a sharp drop.

The AI news cycle of the summer captured themes including the challenge of starting a career, the importance of technology in the China/U.S. trade war, and mounting anxiety about the impact of the technology. But in terms of finance and investing, Deutsche Bank sees markets “on edge” and hoping for a soft landing amid bubble fears. In part, it blames tech CEOs for egging on the market with overpromises, leading to inflated hopes and dreams, many spurred on

Still, Wall Street is not Main Street, and Deutsche Bank notes troubling math about the data centers sprouting up on the outskirts of your town. Specifically, the bank flags a back-of-the-envelope analysis from hedge fund Praetorian Capital that suggests hyperscalers’ massive data center investments could be setting up the market for negative returns, echoing past cycles of “capital destruction.”

AI has captured the market’s imagination, with Cox and Abrudan noting, “it’s clear there is a lot of hype.” Web searches for AI are 10 times as high as they ever were for crypto, the bank said, citing Google Trends data, while it also finds that S&P 500 companies mentioned “AI” over 3,300 times in their earnings calls this past quarter.

Stock valuations overall have soared alongside the “Magnificent Seven” tech firms, which collectively comprise a third of the S&P 500’s market cap. (The most magnificent: Nvidia, now the world’s most valuable company at a market cap exceeding $4 trillion.) Yet Deutsche Bank points out that today’s top tech players have healthier balance sheets and more resilient business models than the high flyers of the dotcom era.

Despite the relative restraint in share prices, AI’s real risk may be lurking away from its stock-market valuations, in the economics of its infrastructure. Deutsche Bank cites a blog post

“Now, remember, revenue today is running at $15 to $20 billion,” the blog post says, explaining that revenue needs to grow at least tenfold just to cover the depreciation. Even assuming future margins rise to 25%, the blog post estimates that the sector would require a stunning $160 billion in annual revenue from the AI powered

Deutsche Bank itself isn’t as pessimistic. The bank notes that the data-center buildout is producing a greatly reduced cost for each use of an AI model, as startups are reaching “meaningful scale in cloud consumption.” Also, consumer AI such as ChatGPT and Gemini is growing fast, with OpenAI saying in August that ChatGPT had over 700 million weekly users, plus 5 million paying business users, up from 3 million three months earlier. The cost to query an AI model (subsidized

Praetorian Capital draws two historical parallels to the current situation: the dotcom era’s fiber buildout, which led to the bankruptcy of Global Crossing, and the more recent capital bust of shale oil. In each case, the underlying technology is real and transformative—but overzealous spending with little regard for returns could leave investors holding the bag if progress stalls.

The “arms race” mentality now gripping the hyperscalers’ massive capex buildout mirrors the capital intensity of those past crises, and as Praetorian notes, “even the MAG7 will not be immune” if shareholder patience runs out. Per Kuppy’s Korner, “the megacap tech names are forced to lever up to keep buying chips, after having outrun their own cash flows; or they give up on the arms race, writing off the past few years of capex … Like many things in finance, it’s all pretty obvious where this will end up, it’s the timing that’s the hard part.”

This cycle, Deutsche Bank argues, is being sustained