Bearish but don't short! Goldman Sachs warns: Anyone shorting tech stocks now is a "fool"

Having been on Wall Street for over 30 years, Jim Covello, the stock research director at Goldman Sachs, knows how painful it is to short a growing bubble, as the market always finds a way to rise month after month.

This has happened in the late 1990s internet bubble and more recently in the cryptocurrency market. The Goldman Sachs stock research director believes that artificial intelligence is likely to face a similar situation, but shorting companies like NVIDIA (NVDA) now could be dangerous, even foolish.

However, Covello has no doubt that a reckoning is coming. He says it may not happen this year, or even next year, but it will happen eventually. In his view, the hundreds of billions of dollars that companies are investing in artificial intelligence will not trigger the next economic revolution, nor can it compare to the benefits brought by smartphones and the internet. When this becomes clear, all stocks that have surged due to this narrative will also fall. Covello says:

"Throughout history, most technological transformations, especially those with revolutionary significance, have witnessed us replacing very expensive solutions with very cheap ones. But now, we are essentially replacing jobs with extremely expensive technology, which is basically the opposite of history."

Covello is becoming a leading figure among a growing number of market observers who are questioning a key argument that has supported the continuous rebound of the S&P 500 index (SPX) since the end of 2022, that the astonishing power of large language models will usher in the next "industrial revolution", at which point, as more and more work is handed over to intelligent machines, corporate profits will soar, increasing efficiency and accelerating growth.

Many on Wall Street believe this is possible, with JPMorgan CEO Jamie Dimon stating his belief that artificial intelligence will bring extraordinary change, with its transformative power potentially as significant as that brought by printing, steam, and electricity. Michael Arone, Chief Investment Strategist at State Street Global Advisors, says that artificial intelligence has brought about a "lasting and unprecedented productivity miracle". Even within Covello's own company, Goldman Sachs Senior Global Economist Joseph Briggs estimates that artificial intelligence will eventually automate a quarter of all work tasks and drive the pace of economic growth.

This speculation has sparked a real boom, with the world's largest tech companies pouring massive investments into this area to extend their dominance into the latest fields. This is good news for companies like NVIDIA, Broadcom, and AMD that provide hardware for artificial intelligence models. Even utility companies are seeing a surge in sales as the industry's demand for data centers skyrockets, leading to massive electricity needs.

However, skeptics argue that the problem is that people's commercial expectations for this technology may be severely overestimated, and if tech giants reconsider their investments, it could pose a risk of a stock market pullback

Don't Be the "Last Fool"

David Bahnsen, founder and chief investment officer of Bahnsen Group, has been preparing for this scenario, avoiding NVIDIA and other large tech stocks because he anticipates a potential "disaster." He said:

"The way we make money is by not holding these stocks after the last fool bought Cisco stock in March 2000. After the bursting of the internet bubble, Cisco's stock price plummeted. If you don't sell these stocks early, you will lose a lot of money."

Although there are few signs of this scenario materializing so far. While tech stocks fell on Wednesday due to market concerns that chip manufacturers would be further embroiled in a trade war, they still remain near historic highs.

Since hitting bottom in October 2022, nearly half of the S&P 500 index's gains have been concentrated in six stocks: Apple (AAPL), Microsoft (MSFT), NVIDIA, Alphabet (GOOGL), Amazon (AMZN), and Meta (META).

NVIDIA's market value has increased by nearly $2 trillion this year and remains one of Wall Street's most popular stocks. Among the 64 analysts tracking the chipmaker, all 64 still recommend buying, even though the stock has risen by nearly 140% this year. Only one recommends selling.

Despite significant investments in artificial intelligence by these companies, the returns have been relatively modest so far.

Microsoft, Alphabet, Amazon, and Meta have collectively invested over $150 billion in capital expenditures over the past four quarters, with most of it going towards computing power to train their large language models and serve customers.

Microsoft has been integrating its product line with OpenAI's technology, with the company stating in April that Azure and other cloud service sales grew by 31% in the third quarter, with AI contributing 7 percentage points, but no specific amount was given.

Amazon expects sales to exceed $600 billion this year, with the company only stating that its AI business has reached "revenue in the billions." During Alphabet's first-quarter earnings call, CFO Ruth Porat acknowledged that "AI is increasingly contributing to Google Cloud revenue."

For individuals like Adam Gold, chief investment officer at Katam Hill, he continues to heavily invest in NVIDIA and believes it is still early to focus on certain metrics. He pointed out that companies like Meta, while not directly charging users, have achieved sales growth by using AI to improve ad targeting and user engagement.

For some customers of cloud computing giants, the benefits are not yet clear. According to a survey conducted by San Francisco-based Lucidworks, less than half of companies investing in AI have not seen significant returns yet. Covello suspects that most companies will never see a return on investment. Since joining Goldman Sachs in 2000, he has been focusing on the technology industry, winning top analyst awards year after year, and was promoted to head of US stock research at Goldman Sachs in 2015.

He predicts that investment in artificial intelligence infrastructure will reach around $1 trillion in the coming years, but for AI to generate sufficient returns, it must be able to help businesses tackle increasingly complex tasks.

In his view, artificial intelligence has shown potential to improve efficiency in certain tasks (such as programming), but it is far from proving that its costs are justified.

He mentioned that if significant use cases do not emerge within the next year and a half, the stock market will reverse. However, he believes that the current narrative around artificial intelligence has not reached that stage yet and may continue to drive investors to buy stocks like Nvidia. He said:

"One of the most important lessons I have learned in the past 30 years is that bubbles may take a long time to burst."