Alphabet’s chief executive, Sundar Pichai, said the company would continue to invest $US12 billion a quarter in developing its AI offerings, saying that tech companies were at the start of a “very transformative” era and the risks of under-investing were dramatically higher than the risk of over-investing.

He might well be right – he said Google’s generative AI was already generating billions of dollars in revenue – but the sheer scale of the investment Alphabet is making in AI and the uncertainty of the returns and their timing caused a collective intake of breath in the market and a selloff of those mega techs most deeply engaged in developing generative AI platforms and products.

Alphabet lost $US54 billion of market capitalisation, Amazon $US58 billion, AI chipmaker Nvidia $US205 billion, Meta $US60 billion, Apple $US99 billion and Microsoft $US118 billion.

The near-hysteria surrounding AI and the mega techs may have abated somewhat but the FANG index is still up more than 27 per cent this year. The selloff appears more of a correction of a sector of the market that had run too far, too fast than a complete loss of faith in the technology’s commercial potential.

Investors seem to have sobered up, now realising how big the required investments in developing and training large-language models are, how significantly that investment will impact earnings over the next few years, how long it will take to generate significant returns on the investments and how unknowable the scale of those returns are at this point.

It may be that AI radically transforms economies and societies over time, but that doesn’t necessarily mean it will produce financial bonanzas for the corporate pioneers or produce them within timeframes that are relevant to today’s investors. The further out the payoffs from AI investments are, of course, the less value should be attributed to them today.

An insight into the depth of the market’s newfound reservations about the AI-driven stocks could be provided next week when Apple, Amazon, Microsoft and Meta are due to release their quarterly results. Nvidia, which ignited the boom in AI stocks, doesn’t report until late next month.

Even before this week, the share prices of the mega techs had been softening even as those of smaller capitalisation stocks were rising, in what is generally described as a “rotation” within the market. The Russell 2000 index of small-cap companies is up 7 per cent since July 10, despite a 2 per cent decline on Wednesday.

The start of the rotation from big-cap stocks to small coincided with the release of US inflation data for May, which showed consumer prices falling for the first time in four years.

The second encouraging reading in two months increased the likelihood of the Federal Reserve Board cutting US interest rates this year, which would provide interest cost relief for smaller companies. The mega techs generate so much cash they have little, if any, net debt and, if anything, they benefit from the impact of higher rates on their massive cash reserves.

It remains probable that if the Fed is to start lowering US rates it will be at its September meeting rather than the Open Market Committee meeting that is scheduled for next week, although the highly-respected former president of the Fed’s New York bank, Bill Dudley, argued in a Bloomberg column this week that the central bank should cut the federal funds rate (the US equivalent of the Reserve Bank’s cash rate) at next week’s meeting.

Dudley had previously argued that rates should remain higher for longer but now says most US households’ savings have been depleted, the momentum from Joe Biden’s major spending programs is fading, the employment growth rate is dwindling and the unemployment rate is creeping up and getting close to the point that invariably signals a recession.

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He believes the Fed will play it safe and wait until September, given that is the markets’ expectation, but says that dawdling before reducing rates unnecessarily increases the risk of recession.

With US GDP data for June about to drop and June inflation data due next week, there’ll be a better sense of how the US economy is tracking and a better sense of what the Fed might do over the course of the rest of the year.

Rate cuts are positive for sharemarkets and could further broaden the base of future sharemarket gains, reducing the concentration risk for investors posed by the AI-driven fixation with a handful of the mega techs.

Given that the combined market caps of the Magnificent Seven peaked at close to a third of the capitalisation of the entire S&P 500, it’d be a somewhat less exciting market but one less vulnerable to the bursting of an AI-driven bubble.