Bridging the Gap

What is the likelihood that, over the next two years, the stock of the world’s most valuable company by market capitalization, NVIDIA, will lose half of its value at the same time as the main semiconductor stock index to which it belongs, SOX, loses a quarter of its value?

On the most basic level, this question can be seen as a referendum on the future course of the AI boom, with the stock most closely associated with that boom – NVDA – serving as a proxy. The most salient set of questions is whether the AI industry is in a “bubble”, as is often alleged, and if so, how likely it is that a significant correction will occur within this time period. The SOX criterion adds a second dimension that connects the AI economy with the broader stability of financial markets, thus inviting us to also carefully consider non-market events that could affect this nexus of equities.

From a strictly historical, securities-based perspective, the fundamentals point toward this scenario being quite plausible. Equities as a rule tend to be volatile securities. NVDA itself exhibits considerable smaller-scale volatility today, fuelled by its skyrocketing valuation, and has a history of more severe volatility too: the stock has dropped by 50% four times over the course of the past twenty-five years. And the SOX index also fell by 25% during each of these episodes.

Yet most of that historical period predates the AI boom and the corresponding ascent in NVIDIA’s market capitalization. No company that was number-one in market cap for at least two quarters in a year has ever lost 50% of its equity value in the subsequent two years. In other words, NVIDIA might be “too big to fail” in the absence of the AI bubble bursting calamitously or truly market-shaking outside events.

The Swift Centre forecasting team estimated the likelihood of this question resolving positively at 23%. Their forecasts were fairly tightly clustered around the median, with some outliers tilting to the high side (range 11% to 37%).

In light of the security’s fundamental characteristics, as noted above, the forecasters saw the minimum likelihood of a 50% drop in NVDA’s valuation at one-in-ten, and the base-rate likelihood of such a drop at 35%-35% considering the last ten years and current option prices. NVDA and the SOX index were seen as likely to be correlated enough in most circumstances, if not all, that they can be considered as a unit.

At the same time, the forecasters were generally sceptical of the theory that the AI market is in a bubble – at least one that is likely to pop in dramatic enough fashion to decimate NVDA’s value (as opposed to a smaller-scale correction that would not bring AI development to a halt or hobble financial markets as a whole) and that is likely enough to occur within the two-year time frame. They tended to see demand for NVDA’s chips, and for semiconductors more broadly, remaining sufficiently robust in most scenarios – a fundamental support for the company’s valuation and that of the index.

Major non-market events were seen as the most plausible causes of a qualifying correction in NVDA and SOX. The most obvious candidates were a China-Taiwan conflict that would disrupt the global semiconductor chain – a non-trivial risk, in the forecasters’ view – and a global recession that would slow economies everywhere. But these factors were more than counterbalanced by a general opinion that a severe AI winter is, in itself, comparatively unlikely. Together, these internal and exogenous factors combined to pull down the median forecast from the assumed base rate to the final 23%.