Wednesday, 8 October 2025

Artificial Intelligence or Authentic Stupidity?

Over the past three years, the AI/LLM boom and its associated capex supercycle has been having a profound effect on the economy, financial markets, and society (though not on corporate productivity, as we’ll discuss). However, as unrestrained AI optimism and its financial market manifestations have continued to mushroom, evidence has been quietly mounting that many of the boom’s foundational assumptions are starting to buckle. The divergence between the two has become so stark that there is a strong case to be made that the boom has now morphed into a fully-fledged bubble, and of a size that makes the dot.com bubble look positively quaint.

There is no denying that the capabilities of LLMs are amazing; I now use ChatGPT on a daily basis. Initially the hype seemed justified, which is why I refrained from viewing it as a bubble, despite my contrarian instincts. The capabilities of LLMs seemed impressive and were advancing at a rapid clip, with “scaling laws” promising more to come – perhaps all the way to AGI and beyond. The societal changes and productivity benefits that would accrue from such an advance would be profound.

But recent developments are casting significant doubt on that trajectory, and people’s rabidly bullish expectations appear increasingly decoupled from the evidence. As I will discuss, the so-called “scaling laws”, which are a critical foundational assumption, appear to be faltering, while the promised productivity benefits have thus far utterly failed to materialize. LLMs increasingly appear to have structural limitations in their reasoning capabilities and an incurable propensity to hallucinate, which iterative LLM architectures may not be able to correct.

But these “inconvenient truths” are being roundly ignored. Undeterred by recent setbacks, the industry is plowing ahead with another order of magnitude increase in compute investment to levels fast approaching half a trillion dollars a year, while stock market and AI start-up valuations have continued to levitate. At this stage, a boom with rational underpinnings appears to have morphed into an irrationally exuberant bubble, and its bursting could have major consequences – both economic and financial market.

Before proceeding to my argument, a caveat is in order. AI is a rapidly evolving field, so any “etched in time” views will always come with a significant risk of looking foolishly wrong in hindsight. In situations of high uncertainty and rapid change like this, it is best to keep one’s views fluid and adaptable to new evidence. But right now there seems to be such a growing divergence between recent technology trends and broader market perceptions that I feel compelled to write something.

To the extent I am right, the implications will be truly massive. This really is a $10tr+ dollar question. The current AI capex supercycle is acting as a major economic stimulus at a time when other parts of the economy are exhibiting signs of weakness, and has supercharged the stock market even more given the large index weighting and high multiples of its (now many) constituents. And it’s not just the usual Mag-7 suspects: MSFT, GOOGL, AMZN, and META (expensive but not egregious); TSLA (outrageously egregious as besides Elon-fever, it has come to be seen as an AI play – previously autonomous vehicles/robotaxis, and now the promise of AI robots, notwithstanding failing to execute on the former); and NVDA and AVGO (great companies but egregious if one does not believe the current level of AI capex to be sustainable).

It also includes all the chip supply chain companies (TSMC, and memory makers SK Hynix, Samsung, Micron) and semi-equipment companies (ASML, Lam, Applied Materials, KLA). While multiples here are not outrageous, in an AI capex bust their earnings will fall precipitously. Far more egregious is perceived AI beneficiaries like Palantir (now sporting a US$430bn market cap on just US$4bn of revenue), filtering down to companies you wouldn’t expect to be AI plays like Axon Enterprises – a US$56bn market cap taser and body camera company trading at 100x earnings as people believe they will be able to apply AI to its copious data. The ranks of the anointed also now include Oracle, which a few months ago added US$200bn in market cap in a single day on signs it is becoming a major AI cloud computing play.

Moreover, Chinese large cap tech companies have also recently surged (notably Alibaba), as it has come to be seen as an AI play instead of merely a structurally challenged e-commerce company in an increasingly saturated and price-war prone market with poor capital allocation to boot. Such is the level of AI mania at present that news the company would spend US$50bn on AI data center capex (buybacks and dividends will have to wait further) has been rewarded with a 50% pop, adding US$150bn in market cap. AI is also now estimated to comprise a low-single-digit (and rapidly growing) percentage of US electricity demand, so even utilities have rallied and are seen as AI-adjacent plays. The AI boom's tentacles are long and varied. When you add all these up you are talking about a material minority of the global market cap.

In short, the sustainability of the current AI capex supercycle is absolutely critical to the market (and economic) outlook, and with an asymmetry – valuations largely assume the boom will continue unabated, whereas if the market is wrong, many valuations could fall 50-90%. The stakes are huge and of a scale that, in a bear scenario, could lead to a market rout of historical proportions, with the “LLM craze” taking its place alongside the dot.com bubble, GFC, and covid as the notable historic market events of this century.

This doesn’t necessarily mean, by the way, that in the future AI won’t be transformative. The internet turned out to be everything the bulls hoped and dreamed it would be in the 1990s, and more. But we still had a huge bubble that burst in 2000-03. You don’t have to be pessimistic about the long-term outlook for AI to believe there is a huge mismatch between current expectations and the realistic medium-term outlook. And economic realities also matter, not just technology trends.

Moreover, though rapidly slowing, there will likely continue to be at least some progress in AI/LLMs. The pertinent question is whether it will be enough to justify the prodigious economic costs. There is already a huge mismatch between AI costs/capex and revenues, and it appears likely to rapidly worsen from here. If that indeed proves to be the case, a financial reckoning is only a matter of time.

 

From justified hype to bubble; scaling laws “buckle”

Like most bubbles, the LLM mania started out with solid foundations, but is now being taken to morbid, irrational excess. The initial LLM hype was justified. Not only did the output of early LLM models (particularly ChatGPT-3) wow and amaze, but they seemed to be improving at a rapid clip and adhering to so-called “scaling laws”. The latter was a belief/assumption/empirical observation that all that was needed to generate more performant models was to (after scraping all data from the internet) bring orders of magnitude more compute to bear, increase the number of parameters, and train the models for longer, and boom, you got a major increase in performance.

This optimism was reinforced when scaling laws held up for ChatGPT-4 – an order of magnitude more compute yielded a huge gain in performance exactly in line with scaling law predictions. People were giddy with excitement and confidently extrapolated the gains, with scaling laws seemingly implying a fast-track to AGI.

To the extent these assumptions held, the hype was justified. AGI being just a few years away – this was a very big deal indeed. This is what I believe caused people such as Eric Schmidt to argue AI had actually been “under-hyped”. It was going to be revolutionary in so many ways. Moreover, along the way it came to believed that LLMs were not just statistically predicting text, but were also developing an internal model of the world – imbibing not just tokenized words but the underlying meaning behind them. After all, the best way to predict text may be to actually understand the meaning the words represent. I also subscribed to this view for a while, and it did seem to point to the genuine emergence artificial intelligence. The future looked interesting indeed.

 

Houston, we have a problem…

The problem is that recent evidence is calling into question many of these foundational assumptions. The most significant development is that the “scaling law” appears to be breaking down – more compute is no longer delivering proportionately meaningful gains in model performance. Indeed, it is even possible future models start to get worse on account of AI “pollution” of the training data set (discussed more below). 

Moreover, evidence is also emerging that LLMs have fundamental limitations in their capacity to reason, and in contrast to early speculative optimism, it appears they do not in fact have internal models of the world and are instead simply sophisticated imitation engines. Unreliable output, or “hallucinations”, are proving persistent, and may in fact be an incurable feature of LLM architectures, rather than merely temporary nuisances. To the extent this proves to be the case, LLMs may be a dead end and genuine breakthroughs in AI/AGI may require us to go “back to the drawing board” with RL and/or entirely new and more targeted architectures, potentially a tougher grind and setting us back decades relative to prior expectations.

The most significant development is that since ChatGPT-4, which was a major improvement over v3, scaling laws have started to break down. ChatGPT-5, which took more than 2yrs to develop and was released late (a possible indication OpenAI encountered problems with it behind closed doors) was a major disappointment, at best delivering only marginal improvements (some users even believe it inferior to ChatGPT-4) despite another order of magnitude of compute being brought to bear. More broadly, the pace of gains in foundation models appears to be rapidly decelerating and competing model performance with divergent access to computing resources are asymptotically converging, instead of the largest players pulling further and further ahead (which you’d expect in a scaling-law world).

Emphasis is also shifting from pre-training to post-model training, including using human RL techniques to tweak/improve outputs. If pretraining was still yielding huge “scaling law” gains, they would not be bothering with post training – the effort would not be worth it and dwarfed by pretraining gains. Often these tweaks are focused on narrowly boosting performance on various model benchmark tests, and so are fairly cosmetic in nature. This shift in emphasis is further circumstantial evidence.

The scaling law is of course not a law, but simply an empirical observation, assumption, and hope. No such natural law exists that promises smarter LLMs in exchange for more compute, and the assumption of infinite scaling rather than diminishing returns was arguably always questionable, as observers like Gary Marcus have long argued. If you have the same pool of data (most of the internet has already been scraped), is it really reasonable to believe that each additional order of magnitude of compute will yield the same exponential improvements, rather than rapidly attenuating ones?

In addition to scaling issues, there is also growing evidence that LLMs have fundamental limitations in their reasoning capabilities. A recent influential study  “The Illusion of Thinking” scrutinized chain-of-thought LLMs and concluded that AI reasoning is more illusory than real. This is a fundamentally why “hallucinations” have not gone away, and it looks increasingly likely they are an inherent feature of LLM architectures.

Moreover, the idea LLMs have been developing an internal model of the world is also being questioned. This is evident in the fact that, despite all the sophisticated output they can generate, they still make very rudimentary mistakes. Cal Newport highlighted that GPTs will sometime suggest illegal chess moves, which demonstrates a fundamental lack of any “world model” on chess, while Gary Marcus noted that diffusion models often give you the wrong quantity of (for instance) tennis racquets when requested. This is consistent with the models having no understanding of their generated output. LLMs are imitation models, not reasoning models; sophisticated text guessing engines. They provide the illusion of intelligence, but don’t actually understand anything. They can’t even differentiate between when they are being trained and when they are being deployed.

Indeed, at a more fundamental level it can be argued that LLMs are not intelligent at all. In this excellent deep discussion on the true nature of intelligence (see also this presentation here), Rich Sutton argues persuasively that LLMs are not genuinely intelligent because they are not capable of learning and adapting through goal-driven interaction with the real world. Unlike intelligent agents like humans, they do not apply themselves and learn at the same time through active contact with their environment – they rely on training using second-hand human-acquired data expressed in text, and in deployment, they are in stasis and do not acquire new knowledge or adapt to new experience. They therefore have a fundamental inability to iteratively learn from the world they find themselves in.

Sutton believes LLM's fundamental architecture makes the acquisition of genuine intelligence impossible; the best they can do is synthesize (plagiarize?) existing human-generated input, and reproduce it with some inherent degree of unreliability. Moreover, they are incapable of generating genuinely new insights; if they were built in 1900 for instance, they would be unable to come up with the theory of relativity de novo before Einstein, as they have no capacity to interact with and adaptively learn from the real world. If he is right about this, LLMs could prove to be a fundamental dead end in the pursuit of AI.

Another issue not being talked about nearly enough is as more content on the internet becomes AI generated, the training pool of data will increasingly become “polluted”. AI was initially trained on 100% human input, and while that input is varied in its quality, it at least represents the thoughtful reflections of human agents acting in the real world. AI content however contains random LLM generated hallucinogenic noise, and as LLM adoption grows and more and more of the scrapable online content itself becomes AI generated, AI “pollution” will worsen, conceivably to the point where the quality of models may actually start to decline (this is speculative, but a real possibility).

This Kurzgesagt video discusses this dynamic well. Their efforts to use AI to facilitate the generation of content on brown dwarf planets led to them encountering many fake AI hallucinated studies/facts, which their meticulous source checking uncovered. Subsequently, other less rigorous channels have included the fake AI content in their videos, which have acquired hundreds of thousands of views. In the future, AI models will use videos with false AI hallucinated facts as authoritative training sources, and they have no architectural way of correcting the errors as they have no internal model of the world or intrinsic capacity to directly interact with the world or reason, only to assimilate what they are fed. This potentially portends a major future problem, as LLMs will be unable to distinguish between AI generated content and human-generated content.

Consuming LLM output is to some extent akin reading the output of a bad journalist. If you know little of the underlying facts, the output seems credible and impressive. But the more you know about actual events, the more factual inaccuracies are apparent to you. LLM output is superficially impressive if you lack underlying domain knowledge, but the more you know, the more the limitations of the LLM output are apparent.

Such is the degree to which faith and hype rather than first principled thinking is being used today, is that “AI” has now become a synonym for “LLM”. But LLMs are not artificial intelligence, they are a very particular neural network algorithm that yields a sophisticated text guessing engine. That can be useful in some contexts, but it increasingly appears as though they have fundamental limitations that will not be a path to AGI; will not create genuine scientific breakthroughs; nor trigger a productivity miracle.

 

Where are the productivity benefits?

This brings me to the next point – where are the vaunted productivity benefits? At the same time as gains in LLM capabilities have started to rapidly attenuate (despite the economic cost of those improvements rapidly mushrooming), more and more studies have been emerging pointing to a conspicuous lack of productivity benefits from LLM adoption (this ColdFusion video, from a techno-optimist no less, is a useful primer). A highly quoted recent MIT study found that as many as 95% of companies that have tried to internally adopt AI have seen no productivity benefits. Surprisingly, there has even been a study showing coders using LLMs were less efficient. Cal Newport attributes this to less deep work and reduced developer focus, in addition to the inevitable need to debug mistakes in the GPT generated code.

Indeed, there is even evidence it may be reducing corporate productivity through “workslop”, which leads to the introduction of (sometimes well hidden) errors that require human effort to discover and correct. There are also doubtlessly inefficiencies associated with lower-level employees being forced to scramble to meet management dictates to introduce “AI” into workflows, which LLMs are currently fundamentally unable to deliver.

At the dawn of the internet, it was widely believed it would be an unmitigated good for human productivity by providing the world with easy and instantaneous access to information. While we have seen some of this, we have also seen people reduce focus and sink copious amounts of time into social media and online gaming. On net, it is questionable whether there have been any net productivity benefits. In a perfect world LLMs could boost knowledge acquisition, but it is probably just as likely it makes people lazier; corrodes deep work and focus; and makes people more susceptible to misinformation by obfuscating the delineation of genuinely authoritative sources, and by reducing the consumption of primary sources in favour of secondary, LLM-generated ones.

Personally, I think in niche situations (such as for myself), LLMs can be a productivity booster by speeding up knowledge acquisition, and my instinct is that it probably can aid the best (or at least the most motivated) coders. However, LLMs are only useful as a supervised tool, not a wholesale human replacement. They are most useful for people where “approximately right” answers are good enough (such as stock research), and where a knowledgeable operator with critical thinking can probe and question answers and independently verify important claims. It is best viewed like talking to a knowledgeable human; you can learn a lot but you also don’t/shouldn’t trust that everything they say is 100% correct; you must triangulate it and interrogate answers that are unsatisfying.

To that end, LLMs are a useful resource for certain high-performing people in niche occupations, but they will not cut it for most enterprise applications where 100% accuracy and reliability are required to automate fundamental business processes, as LLMs are unable to deliver that degree of dependability. All the talk of AI replacing humans and yielding a productivity bonanza were all premised on an assumption that scaling laws would hold and carry LLMs to AGI and hallucinations would fade, but that naïve extrapolation is inconsistent with what is currently happening.

LLMs seemed (and perhaps were) too good to be true – the idea we could get to AGI simply by hooking up more GPUs & letting em run. But these “inconvenient truths” mean achieving genuine AI and its associated productivity benefits might turn out to be much more difficult, if not intractable – like autonomous driving which has been “just around the corner” for 15 years (and we are still only at L2 vs L5 for full autonomy).

 

The last shot on goal

Notwithstanding the above, the AI industry is nevertheless doubling down in the face of faltering scaling laws and ramping capex meaningfully further. We have one more order of magnitude to go, and we are evidently going to try it. OpenAI’s Stargate project aims to bring as much as half a trillion dollars of compute to bear on its next models. This ongoing commitment is one reason AI stocks have surged over the past month despite tangible evidence piling up of a bubble, because in the short to medium term the boom will roll on and picks and shovel providers will continue to make bank.

But this latest order of magnitude capex boost to increase LLM performance will be the last. The next leg to US$5tr is not affordable even for the hyperscalers. Datacenters (including non-AI) already consumed 4.4% of US electricity in 2023 and would have grown sharply since then, with a growing share of energy use coming from AI training (the US DoE projects 6.7-12% of all US electricity demand coming from datacenters by 2028). Let’s call it circa 2% for AI specifically at present. It can’t go to 20% and then 200% (granted more performant chips will help, but even with Nvidia’s heady gains in chip performance – which will also attenuate with time – power consumption and capex has been mushrooming).

If the next leg of capex fails to yield meaningful gains, the breakdown in scaling laws and the inherent limitations of LLMs will be undeniable. The most expensive frontier models will be perhaps two orders of magnitude uneconomic, forcing a pivot to more energy efficient, but less powerful models (a la DeepSeek), with radically scaled-down commercial potential. There will then be an inevitable collapse in capex (especially with the underlying chipsets themselves becoming more performant and quickly obsoleting legacy chips), and the industry will be left with copious amounts of overcapacity (housed mostly by the big cloud companies, as well as certain foundational model companies such as OpenAI, that are shelling out hundreds of billions of dollars annually for LLM GPU training clusters).

In this scenario, the share prices of many AI companies will likely fall 90%+; Nvidia will most likely fall 60-80%; chip supply chain companies will probably fall 50%; and the hyperscale cloud compute players, who will be facing revenue pressures and massively increased AI-kit depreciation charges, could also fall 30-50%, as cloud earnings and growth crater and aggressive future growth expectations are curtailed. And AI startups will fail in large numbers. OpenAI will likely survive given that it is Microsoft backed and ChatGPT will still be useful and capable of commanding a number of consumer subscriptions, but in a vastly diminished form and at a significantly lower valuation.

But all of this begs the question: why, given the evident deterioration in scaling laws, is the industry still ramping capex like crazy? Do they know something we don’t? It might have as much to do with them desperately trying to find a solution to floundering scaling laws than their continuing unwavering belief in them. A “multi-shot” approach (e.g. get 100 answers instead of 1 and aggregate them, and/or think longer) is one possibility – another shot on goal they hope yields the targeted performance improvements.

But the truth is, foundational model companies and other AI start-ups have already gone all in on LLM scaling laws and have no alternative/plan B. Most AI/foundation model companies are losing prodigious amounts of money and need to keep the scaling dream alive to keep raising capital. Given the whole AI ecosystem (rather than pick and shovel cloud providers, who are making money for now) is losing money, admitting defeat would cut off funding and put them all on a fast track to bankruptcy.

Moreover, people do not want to risk taking a contrarian stance and being wrong. What if LLMs do scale to AGI”? If you don’t invest, you’ll be left behind and look foolish for dropping the ball – it might cost a CEO his job. In this interview, Marc Zuckerberg used the rationalization “we can afford it, and we can’t afford to risk missing out” to justify spending several hundred billion dollars on LLM training kit. Meanwhile, the cloud companies are simply responding to strong compute demand from the loss-making AI complex. They need to invest to meet that demand or else cede share in what could be a major future growth driver for the cloud computing business. But what if the demand dries up and they are left with hundreds of billions of underutilized kit? They are willing to take that risk, because they can afford it, and because they can’t afford to risk missing out.

But what about Jenson, who remains unremittingly bullish? Indeed, he is now taking major principle stakes in AI companies/customers, including a US$100bn investment in OpenAI (which he considers a sure bet)? I have long been a huge admirer of Jenson Huang, and have followed Nvidia for 10 years (though never owned the stock). I have found him highly competent, incredibly articulate, down to earth, and “no bullshit”. Despite my contrarian instincts, for a long while I refrained from calling (or believing) NVDA to be a bubble stock, as there was previously real substance to the LLM boom while scaling was holding.

NVDA is a phenomenal company with tremendous executional capabilities and a robust CUDA developer ecosystem, and their relentless pace of innovation and execution makes it pragmatically impossible for anyone to catch them – so long as the environment remains fast moving. All of the best people want to work there, to work with the best and brightest and have Nvidia on their CV. Jenson has single handedly built one of the world's best companies and is a living legend.

But in Jensen’s most recent interview (here), this was the first time it struck me that he may have allowed himself to be swept up in the hype; it’s been a giddy ride to date so can you blame him? Perhaps he is right? Or perhaps he is just really good at running a chip company and has succumbed to hubris – he is, after all, human (barely). Time will tell.

 

What to do about it?

I don’t envy large institutional managers. Like in the dot.com bubble, if you bet against it too early, and/or are ultimately proven wrong, it can lead to disastrous career-ending underperformance. However, if you are right and can weather the near-term performance pressures, the bubble can create an opportunity for career-defining outperformance by dodging the fallout. The current set up appears analogous. Fortunately as a niche boutique manager, I can just choose to not play the game, but large institutional managers have a tougher hand to play (though in reality most will just market weight).

That being said, now is a slightly easier moment, because stock valuations for the big AI tech companies are already at giddy levels that embed years of very robust growth, while the fundamentals have already started to deteriorate. That doesn’t mean if you avoid the stocks, you can’t still underperform catastrophically as valuations go from high to absolute lunacy (and in some cases already have), but it is nevertheless less risky to bet against LLM mania now than it was a year or two ago. Still, markets can do crazy things for long periods of time – good luck to you, you’ll need it!

For the rest of us, the best opportunities may lie in purchasing stocks that have been sold off on excessive AI disruption fears (I don’t like shorting for reasons discussed in prior posts, and long dated put options are likely expensive atm). Gartner is one such example, though the stock is only modestly cheap atm, and the market multiple overall will likely decline in a major AI-led bear market. I have identified one candidate in France but I’m not willing to share it at this point as I’m still buying.

What if I’m wrong? Then I lose the opportunity to buy very expensive stocks that probably will not generate above-average returns in the long term from current levels even if the LLM boom continues unabated; and even if they do, came attendant with very considerable ex ante risks. That is an opportunity I'm more than comfortable passing up.

That being said, I must reiterate the caveat I outlined earlier. Aside from this being a complex and fast moving area where even career pros have widely differing opinions, I am not a tech/AI expert and have spent only perhaps 1-2% of my time on it, though my views lean heavily on experts – particular credit goes to Rich Sutton, Cal Newport (especially this interview), and Gary Marcus for the bear case; on the bull case I have got the most insights from Jenson Huang and Geoffrey Hinton. I could be wrong.

It will be interesting to see how events develop. A bust is more likely to occur in 2027-28 than 2026 as we won’t see the outcome of recent scaling efforts until then, though it is always possible cracks in the veneer appear earlier and markets succumb in advance (and any associated reduction in available funding for AI start-ups will have a reflexive impact on compute demand). But don’t bet the farm – at the end of the day, “who the fuck knows” is the safest conclusion to reach on such a complex, fast evolving issue.


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