AI Boom Faces Reality Check

Japan's stock market remains susceptible to significant fluctuations due to uncertainty over artificial intelligence (AI) investments, according to Masamitsu Oki, investment director at Five Star Asset Management. He warns that AI-related stocks have become akin to gambling, with investors facing considerable uncertainty regarding the industry's long-term prospects.

This sentiment arises as shares in AI and semiconductor companies face renewed selling pressure following the Democratic Party's sweeping victory in the U.S. midterm elections. The prospect of tighter regulation potentially slowing data center construction, particularly in politically sensitive states, has raised concerns among investors.

The Nikkei 225 experienced a sharp decline on November 6, followed by a rebound of over 1,000 points on November 9, highlighting the heightened volatility in technology-related shares. Oki explains that investors had largely anticipated a Democratic victory but were unsettled by the magnitude of the result and the potential impact of political opposition on data center investment.

Subsequent comments suggesting continued AI infrastructure spending and shifting development locations have helped restore confidence, but Oki views the rebound primarily as a reaction to excessive selling.

The fundamental challenge lies in investors' inability to reliably predict the AI industry's evolution over the next five to ten years or the performance of individual companies as the technology advances. Even seasoned investors struggle to forecast the eventual winners, future earnings, or how AI will transform existing industries.

Despite this uncertainty, substantial capital continues to flow into AI-associated companies, leading to exaggerated price movements in response to minor shifts in expectations. Japanese semiconductor companies and manufacturers of chipmaking equipment have been particularly vulnerable during the recent correction, with their share-price declines often surpassing those of major U.S. hyperscalers.

Oki notes that Japanese companies have attracted strong interest as suppliers of equipment, components, and materials for AI infrastructure expansion. However, this exposure has now become a weakness as investors reassess the pace of future data center construction. Companies heavily reliant on semiconductor capital expenditure are particularly sensitive to indications that U.S. technology giants may reduce or delay spending.

Kioxia serves as an example of how unusually concentrated buying positions have contributed to market instability, with many of these companies trading at low price-to-earnings ratios despite potentially strong earnings prospects.