Prediction: The Artificial Intelligence (ai) Bubble Will Burst In 2025. Here's Why.

When the curtain closes on 2024 in less than two weeks, it'll likely represent another banner year for Wall Street. The iconic Dow Jones Industrial Average, benchmark S&P 500, and growth-powered Nasdaq Composite have each ascended to multiple record-closing highs this year.

Though there have been a confluence of factors lifting Wall Street's major indexes to uncharted territory, including better-than-expected corporate earnings, stock-split euphoria, and Donald Trump's November victory, nothing is creating more buzz than the artificial intelligence (AI) revolution.

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The long-term addressable market for AI is practically limitless. Software and systems empowered with AI can become more proficient at their assigned tasks, and can evolve and "learn" without human intervention. It's why the analysts at PwC estimate AI will add $15.7 trillion to the global economy by the turn of the decade.

In response to this generational opportunity, top-tier AI stocks have soared -- and with good reason.

Nvidia (NASDAQ: NVDA) has gained nearly $2.9 trillion in market value since the start of 2023, with the company's graphics processing units (GPUs) becoming the undisputed top choice in AI-accelerated data centers. Last week, AI networking solutions specialist Broadcom became just the 11th publicly traded company globally to reach a $1 trillion nominal valuation. Meanwhile, AI-driven data-mining specialist Palantir Technologies (NASDAQ: PLTR) is nipping at the heels of a 1,000% gain over the trailing-two-year period.

These represent just some of Wall Street's prominent tech stocks that have soared on the expectation that demand for AI hardware and software will change the corporate landscape.

But while Nvidia's and Broadcom's growth forecasts have knocked even the loftiest analyst expectations out of the park, there are reasons to believe the artificial intelligence bubble will burst in the new year.

History has a flawless track record of upending parabolic rallies in next-big-thing innovations

Among the catalysts that could halt the nearly parabolic climb AI stocks like Nvidia and Palantir have enjoyed, none stands out more than history. Although history isn't a timing tool, it does have an immaculate track record of forecasting eventual downside in market-leading businesses on the cutting-edge of next-big-thing innovations.

Approximately 30 years ago, the internet began going mainstream and positively changed the corporate growth arc forever. However, the utility of the internet wasn't fully understood by businesses for many years, which is why we witnessed the dot-com bubble take shape.

Since the advent of the internet, we've witnessed plenty of next-big-thing technologies, innovations, and trends, including genome decoding, 3D printing, blockchain technology, cannabis, and the metaverse. The problem is that they've all endured an early stage bubble-bursting event.

Without fail, professional and everyday investors have consistently overestimated how quickly a new technology or innovation would be adopted and utilized. This eventually leads to the disappointment that causes market leaders of these next-big-thing trends to lose 80% to 99% of their value.

To be clear, I'm not in any way suggesting AI can't be a game-changing technology. What I am saying is that all new technologies and innovations need time to mature. The simple fact that most businesses can't lay out a clear plan as to how they'll deploy AI to generate a positive return on their investment is a pretty good indicator that we're in a bubble.

Removing GPU scarcity would quell investor euphoria (and margin)

Another reason the AI bubble can burst in 2025 is due to the expected resolution of GPU scarcity that's sent Nvidia's stock into the stratosphere.

Demand for Nvidia's hardware has been otherworldly, with orders for its H100 GPU, commonly known as the "Hopper," and its successor Blackwell GPU backlogged. When the demand for a good or service handily outstrips its supply, it's normal for its price to climb. Earlier this year, Nvidia was commanding around $40,000 for its Hopper chip, which is up to a 300% premium to what Advanced Micro Devices was netting for its Insight MI300X GPUs.

In other words, Nvidia has been able to use AI-GPU scarcity to its advantage to increase the price point of its hardware and pump up its gross margin to the mid-70% range.

However, I fully expect this scarcity advantage to wane in the new year. AMD is rapidly increasing production of its chips and recently introduced its next-generation MI325X GPU.

Additionally, many of Nvidia's top customers by net sales are internally developing AI-GPUs to use in their data centers. Even though Nvidia's chips should remain superior from a computing standpoint, these internally developed GPUs are going to be substantially cheaper and easy to access. It's a recipe for Nvidia to lose valuable data center real estate, and for its pricing power and margin to decline.

Image source: Getty Images.

The U.S. government can put the kibosh on the AI rally

Besides history not being on the AI revolution's side, the AI rally could also be upended because of actions taken by U.S. regulators.

In 2022 and 2023, regulators under the Biden administration announced restriction on exports of high-powered AI chips and chip-related manufacturing equipment to China. This affects leading hardware producers like Nvidia, as well as the company's providing the equipment to produce AI solutions. For instance, semiconductor wafer fabrication equipment company Lam Research generated 37% of its revenue from China during the September-ended quarter, and 39% in the quarter before that.

Under President-Elect Donald Trump, it's unlikely we'll see these restrictions eased or lifted. Trump took a hardline stance toward the world's No. 2 economy during his first term as president, and this is likely to continue when he takes office on Jan. 20.

To add, Trump has opined that he'd impose a 35% tariff on imports into the U.S. from China on Day One. More than likely, this is going to prompt a trade war that strains trade relations between the world's two-largest economies and adversely affects AI product sales to China.

PLTR PS Ratio data by YCharts

AI stock valuations are an eyesore that can no longer be ignored

The final reason the AI bubble will burst in 2025 has to do with historically unsustainable valuation premiums that are currently being assigned to market-leading artificial intelligence stocks.

Over the last 30 years, businesses on the leading edge of next-big-thing innovations have often topped out at multiple of 30 to 40 times trailing-12-month sales. This is where Amazon and Cisco Systems peaked before the dot-com bubble burst.

In 2024, we've witnessed Nvidia top a price-to-sales ratio (P/S ratio) of more than 40, while Palantir Technologies is currently pushing a P/S ratio of almost 69. Although it's impossible to predict when investor euphoria will fade, history has been crystal clear that extended valuations of this magnitude aren't sustainable over the long run.

Though businesses with sustained moats, such as Nvidia and Palantir, are deserving of a premium valuation, relative to their peers, price-to-sales ratios of 29 for Nvidia and nearly 69 for Palantir make no sense.

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John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool's board of directors. Sean Williams has positions in Amazon. The Motley Fool has positions in and recommends Advanced Micro Devices, Amazon, Cisco Systems, Lam Research, Nvidia, and Palantir Technologies. The Motley Fool recommends Broadcom. The Motley Fool has a disclosure policy.