'AI investments come under scrutiny amid profitability concerns; sentiment shifting towards generating cash flows'

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At previous close, the Sensex was down -275.01 points (-0.32 percent) at 84,391.27, and the Nifty was down -81.65 points (-0.32 percent) at 25,758.0

The frenzied investment in the artificial intelligence (AI) space may be facing a reality check as investors are beginning to question the massive capital expenditure without corresponding cash flows and profits, according to economist William Lee. The sentiment is shifting from celebrating large-scale spending towards a more cautious and discerning approach.

Speaking on CNBC TV18, William Lee, chief economist at the Milken Institute, noted that the narrative around the AI trade, which has dominated markets for months, appears to be "fizzling out." The core of the issue, he explained, is the market's realisation that heavy capex spending must eventually translate into tangible financial returns.

"A lot of the investors are asking the question, do we really need this amount of capex spending? And if we do, where's the cash flow that's associated with the profits that come out of all this?" William stated. He pointed to the market's reaction to Oracle's recent performance as a case in point. The company's stock faced pressure after announcing a need for more capex spending without providing investors with a clear roadmap for the expected payoff.

Adding another layer to the discussion, William pointed to an alternative model for AI development being pursued by China. This approach seeks to overcome limitations in raw compute power by focusing more on software and improving the underlying algorithms. This challenges the prevailing belief in the West that superior AI is solely a function of greater computing infrastructure, raising further questions about the necessity of unchecked capex.

Furthermore, the current high-interest-rate environment is acting as a catalyst for this shift in investor sentiment. According to William, higher rates are forcing a discipline on the market, helping to differentiate between genuinely viable investments and more speculative ventures. "It sorts out the cats and dogs in terms of investments from the good investments. And only the good investments will survive," he remarked.

He concluded that the market is no longer willing to fund every project that sounds like a good AI idea in a laboratory or textbook. The blank cheques for AI-related projects are now facing scrutiny, with markets demanding clear evidence of profitability and sustainable business models. "The markets are finally starting to hold back and say, 'hey, we can't finance every stupid project that sounds like it's a good AI idea'," William said.