The AI Bubble Will Pop from Equity Supply Says This $80 Billion Asset Manager | Ben Inker | GMO

Ben Inker (0:00)

In general, the market does about 4% worse per percent of market cap that comes in in an IPO in a given year. So if we are seeing 6% coming in, that's 24% worse than normal. If we're all short of compute, then sure, I'm going to pay for a five-year-old GPU that is less energy efficient. But man, if now the world is suddenly awash in compute, we will have massive defaults on the credit side. We will see companies on the equity side go bust. We will see a problem for the hyperscalers where their return on investment turned out to be lousy.

And is that a minus 18% in the market? No. Right? That is a minus 35 to 50% in the market?

Max Wiethe (0:54)

This episode is brought to you by Sarmaya Partners, who manages a Return to Tangibles ETF LENS.

The Sarmaya Thematic ETF built for a Return to Tangibles. Learn more at sarmayaetf.com and see the show notes for disclosures. Let's get into it. Hello and welcome to Other People's Money. I am joined today by Ben Inker, co-head of asset allocation at GMO, which manages over $80 billion today. Ben, thank you for joining me today.

Ben Inker (1:22)

Thanks so much for having me, Max.

Max Wiethe (1:24)

I want to start out with the big call that you recently made in your Q3 quarterly letter, specifically that you think that equity supply is the catalyst that will bring down the AI bubble and that you expect that catalyst to play out in the next 12 to 18 months. What is it that you're seeing? One, that has you saying AI is a bubble, and two, talk to me about equity supply that we've already seen and why you're expecting more of it to weigh on the market.

Ben Inker (1:50)

Well, there's a lot there. We'll start with the relatively quick version, and we can get into as much detail as you want. Why do we think AI is a bubble? I'd say kind of at the highest level, it is because it is a transformational technological change. Transformational technological changes normally create bubbles.

We've seen it time and time again, whether it was canals or railroads or autos or electrification or the Internet. These events, everybody can tell, oh my God, this is going to change the world. And so they say, well, I really want to be a part of that. And the difficulty with these transformational technologies is, it's hard to know exactly where the money is going to be made, who is going to be the beneficiary.

And it turns out most of the time, most of the money that gets invested doesn't have a great ROI. And since in the early days, one, the returns on investment look good, right? Because you are seeing demand really ramp up.

And because of all of the excitement, you tend to get huge amounts of capital coming in. Now, anytime you have huge amounts of capital coming in, that tends to create a problem, right? It is normally the case that scarcity creates high returns.

And so if you have a lot of capital coming in, you create issues. And as more and more capital comes in, even if it was the case that demand was growing faster than supply for some period of time, eventually, as everybody who participated in the building of that supply seems to be getting rich, more and more people want to be involved, you eventually hit a point where now supply is bigger than demand. And the problem with a situation like that is it's not just the incremental investment that then winds up having a lousy return on investment. It goes and takes the entire corpus of investment in the space and can destroy that. So when the first railroad was built between London and Manchester, it was fantastically profitable. By the end of the UK Railway boom, there were six. And there was no need for six. But the thing is, when there's six, no railroad is going to be making any money. So at the first level, man, this looks a lot like historical situations where we have seen bubbles. Second, when we look at the basic characteristics of this business, what we see is, a lot of this is about either the provision of compute or the provision of AI models. And what we see in both cases is those look more likely to be competitive businesses than winner-take-all businesses. The way you have a really good return on capital is to have a situation where the winner takes all because of network effects, because of returns to the scale, what have you. What you don't want to have is a situation where the switching costs are low, where the differentiation is not that profound between the choices. It is very difficult to find a situation where switching costs are low, lots of things are relatively comparable, and the return on capital is really high.