What Kind of AI Cycle Are We Actually In?

Previously on Dry Powder, Karen Harris, managing director of Baines Macro Trends Group, pressure tested my case for cautious optimism heading into 2026. It isn't as if the US economy has just shrugged off recession risk. It's just not in the top line GDP stats, maybe yet. Today on the show, we turn our attention to soaring tech valuations and the growing fear that a handful of highly valued stocks may be approaching a sharp correction. The unfortunate history of big investment shifts is that enthusiasm that drives the shift often produces a boom bus cycle with early investors acting as the unwitting subsidizers of the technology shift. Railroads, another classic example of this kind of dynamic, is AI different? Well, examine whether those concerns are warranted and how much a potential tech pullback would actually ripple through the broader economy. I'm Hugh MacArthur, chairman of Baines Global Private Equity Practice, and this is Dry Powder. What I wanted to do, Karen, is talk more about one of the trends which you mentioned earlier in our discussion. Are we in a boomer of busts with this AI and tech stuff? I hear about this discussion every time I talk to a GP or an LP. Are we in an AI bubble? What exactly does that mean? What do you say to investors who are worried about a sharp correction in the US stock market in particular? The topic of an AI bubble seems to be one where two analysts can have three opinions, which is great for analysts, but not so great for investors who actually have to do something. So let me see if I can at least commit being to a little bit more of some structure. I think with AI, we like to distinguish between price and quantity bubbles because what happens if the bubble burst is quite different. If you look at the analogy to the dot-com boom in bubble and bust, the quantity build out of real infrastructure was arguably rational, but the price on it wasn't. Essentially, investors very kindly subsidized the cost of a lot of fiber build out, which could be bought and utilized later, which was a great deal for the United States, but not to create deal for those investors. People have made the same argument for AI and the analogy does hold in part. Do we need more data centers? Yes, although some of the contracting where you have sold all of the capacity, it looks great as an investor, but our utilities clients say, "What if we don't have the energy to turn that on?" Then you're not making a product to sell, so there's some tension there. Do we need more cooling systems for those data centers, more power gen, as I just mentioned, to power these data centers? Yes, that all seems to be a very reasonable prediction. Will the chips being put into the servers in those data centers hold their value as well as the dark, vibrant, and the ground after the dot-com bust says, "Shake your prediction." It appears some recent work has shown that chips have actually held their value and been used far longer than basic assumptions. I'm not a chip expert, but that is certainly a question. Do the investors who are deploying capital at a breakneck pace have realistic expectations for their return on the value of that capital? That's also challenging. That gets back to the question of whether we're in a price bubble as well, even if we may not be in a full quantity bubble. The unfortunate history of big investment shifts is that enthusiasm that drives the shift often produces a boom bust cycle with early investors acting as the unwitting subsidizers of the technology shift. There are plenty of people making great arguments, and you'd have to believe that argument to agree not to totally sit on the sidelines, but there are places where it looks soft and risky. So is AI enduring and a technological shift absolutely? Will over time those investments look interesting? Sure. Where you time your own entry and exit from it is what your clients are so adapted doing, but it's really the challenge. So let's say we do have a valuation correction. A sharp one, let's just call it. I'm just picking numbers out of the air, 40 or 50%. A couple of questions, if that happens, who in the economy do you think gets hit the hardest and could any such correction have silver linings in terms of, say, a popular word that we hear all the time in the media affordability? It's hard to imagine a correction of 40 to 50% in AI that would not be more generalized across the market. And then at that point, we're really just talking about what we think of as a trigger for a US recession. Given global dependence on affluent US consumers who in turn are very, their spend is very correlated with stock market performance. That would likely be a global recession. And so arguing about who gets hit the hardest is a little like picking out which mouse gets stepped on by the elephant the least. Our general concern is that the global economy has become quite dependent on the US economy via trade, in spite of tariffs. And the US economy is quite dependent on AI spending plus upper income household spending. And AI and upper income households have one single failure point, which you just mentioned. It's the stock market. And so you hit that point of failure and the chain of pain really would stretch all the way through the world. And just a reminder that we started this little snippet of conversation with a 40 to 50% evaluation or a correction. So let's not walk away from this conversation saying we're definitely hitting a global recession, but certainly that magnitude of correction would create one. Does there any silver lining that you see? Obviously, corrections happen. You describe the dot com correction. They happen all the time. And I personally being a kind of glass half full guy say, yeah, there'll probably be a correction at some point. But will probably still muddle through it. And do you say to your point, you know, your timing may be better, your timing may be worse. But is there anything positive we could say about well, if there is a correction, is there something good that could come from it? Hypothetically, if the equity market deflation spreads to the housing market, which at the magnitude you're talking about is very likely, then yes, inflation writ large, especially the post pandemic surge would get squeezed out. And that totally changes the overall math around affordability. But what that also implies is a massive redistribution of wealth implicitly from the older generations who own that home equity to the younger generations. And one good argue that that may be helpful in breaking some of the underlying stagnation in the US economy, but it's a big shift. We may like the way the distribution looks on the back end of that sort of correction versus where we are today, but that's a pretty wrenching shift to get there. Okay. There are a lot of young job seekers out there. I talk to them. I'm sure you talk to them as well. We read all the time about hiring freezes about white collar layoffs that are supposedly AI driven, which frankly, I'm quite skeptical about this time. Is that narrative backed up by hard job numbers? And if you were advising a job seeker today, what kind of advice would you give them going into the market and what's your kind of view on whether this is a positive environment for young educated people looking for jobs or a negative environment over the next say three to four years? There has been a bit of a narrative reversal. Right? If you talk to people, our parents age, when they think about what a recession looks like, it means you fire the more expensive people and hire more cheap people at the bottom. And it gets back to Scott Galloway's comment on AI that it's corporate ozemic. It kills appetite for hiring. It may not be the reason people are getting fired today. I just don't see at our clients the kind of vertical productivity improvement, like eliminating people up in our clients are using AI in extremely productive ways. Our young analysts, Ben, are just working the same 70 hour weeks doing a different set of activities. So they're not putting red books together, but they just find other ways to deploy themselves. So for young people today, the biggest comfort comes from the historic analogy. If we look back in 1940, MIT did a recent study on this. It's very interesting. If we look at 1940, 60% of the occupations that people have today didn't exist. People do things that nobody did. Now, if we look at that period and break it up, 1940 to 1980, the big surge in the United States was manufacturing jobs and the clerical jobs that supported that manufacturing. But since then, we've seen growth in jobs like healthcare services. 85% of healthcare services jobs that are occupied today didn't exist again in 1940. Now we can argue that some of those jobs aren't necessary, but I think the challenge for parents and both of us are parents of college-aged kids is the job title may not be the right job title for these kids, but are people going off and doing incredibly interesting and productive things in new parts of the economy? Sure. I feel like one area that's really interesting is what's happening with blockchain and crypto, where that for a while felt like a hammer in search of a nail and certainly there are arguments about that for Bitcoin specifically, but with the Genius Act and the implications for what that means for stable coins across borders and the inefficiencies within cross-border money transfer that are only likely to get worse in a post-global world. The challenge of doing financial transactions across borders in a more volatile and regulated world is getting greater and technology is enabling ways to do that with different rails outside of existing systems. And maybe there are listeners who are skeptical about that great, but there are other places where we see inefficiencies that have real opportunities. And so I think young people are going to be doing jobs that don't have vocabulary today. What is a management consultant as my grandparents used to say? And my father would say it's like a doctor for companies and they were just happy. I was some kind of doctor. So that was cool. We're just going to have to get used to those sorts of new things. And people who entered jobs in, if you think about the generation of baby boomers and Gen X, people who entered markets that hadn't existed before, the barbarians at the gate, private equity had really wonderful careers. So that is the optimism. There will be the things that one, the advantage that I feel that the US really has is one most economic innovation happens outside of the capital. It's in many ways a free competitive market for innovation. So companies can try things in California and try something different in Texas and see what works and that there is not a punitive culture around trying and failing. In fact, our favorite narrative is the founded two companies, neither of them worked. Now is having an IPO. And so I can't be pessimistic about the United States. You just can't be anchored to the backward looking narrative of what it is that people do that is rewarding and lucrative. I find that highly compelling. In fact, I found all of this compelling, whether it's talking about economic fragility and resilience in the current times and coming up through 2026 or whether it's our tour around the world and looking at all of the macro challenges and opportunities that investors face or indeed the impact of technology on the industry's subsectors and young people's careers and the outlook for affordability. So it's been a wonderful tour through the macro economy is always Karen. And I want to thank you very much for coming on the show again. I know I learned a ton and it's going to be a really interesting year ahead. So look forward to keeping the dialogue going. Thanks again. Hi, looking forward to being back. Thank you, Hugh. I'm Hugh McArthur. Thank you for listening. [BLANK_AUDIO]