Blue Wave Will Derail the AI Trade but Won't Dismantle the AI Era | Unhedged Position

The Democratic Party taking control of both houses of the Congress will have many implications for the US, and, consequently, the world economy.

And the immediate impact will be felt on artificial intelligence.

It goes beyond some of the rather hardline views put out by Democratic party candidates on AI: it's about how the party, or any political party, typically responds to market forces and economic conditions.

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Over the last few years, AI companies have put on the biggest capex boom in economic history. Such rapid progress has been made possible not just by the promise of what's doable, but also by trying to will longshots into existence, thanks to relentless execution and availability of easy capital.

The recent outflows from the AI trade show the market (which was likely sniffing a Democrat victory) is wising up to two things. One, the AI story is getting a reality check on investments-versus-productivity returns.

The second reason is populism.

The AI boom has created a dichotomy of spectacular nature. US GDP growth remains the strongest it has been in years. Yet, Main Street feels left out. While a few companies corner a big chunk of the gains made during the boom, real wages continue to stagnate.

This will make AI an easy target for Democrats. Trump has made winning the artificial intelligence race a cornerstone of his policy. Democrats will likely blame it for everything from inflation to wages.

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Nowhere is this more evident than in Texas, where Gina Hinojosa -- the first Democrat governor to take office since 1990 -- has promised to pause construction of data centres.

Such an environment likely means that the AI bubble is in the middle of a burst, and that the AI trade will continue to unwind.

And yet, it is clear the AI era is only just starting.

For two seemingly opposite things can be true at the same time. Here's why.

George Soros famously said that bubbles “don't grow out of thin air; they have a solid basis in reality but reality as distorted by a misconception.”

And the reality is the AI is the most transformative force in history. The misconception is that RoI doesn't matter.

The AI boom allowed capital to compress decades' worth of progress into years – progress that would have anyway otherwise been made at a slower pace.

It allowed companies to try out everything that might work. Now that “proof of concept” of generative intelligence has been established, those that survive any shakeout will be able to build on it.

Bubbles burst when two things happen: investors stop playing the ‘greater fool' trade (where they buy on the belief that expensive prices will become more expensive because others are buying) and when cash flow takes precedence.

What they don't do is keep capital from finding its way into forces that create true economic value.

We saw the last example of this 26 years ago. The market thought dotcom companies would change the world. And they did. Just that investors started caring about lesser than before.