AI Bubble

AI Bubble – Party like it’s 1999?

Written by: Raj Chokshi

In the late ’90s and early 2000s, I was just launching my career in this industry. Back then, I was recently married with no kids (today, I have one graduating college, and one in college – time flies!), starting a practice, and witnessing one of the greatest inventions of modern history – the internet. I can’t even remember how we managed before the web. I just recall the sheer joy of dialing in with my AOL dial-up internet, then navigating to my Netscape browser to access Yahoo and the biggest social media company of the time – Friendster. Times have certainly changed; all those companies have practically vanished, Google hadn’t yet emerged, neither had Amazon, and Apple was peddling clunky MacBook computers and iPods.

During that era, I vividly remember reading the financial press, and every company was rushing to ensure they had an “internet presence.” Just mentioning those words would send their stock soaring. We all know how that party ended, and there were several reasons for it. First and foremost, valuations; investors weren’t assessing what they were paying for the company (metrics like price/book, price/earnings, market cap, etc., were all disregarded), instead, they looked backward and assumed past success would continue into the future (markets don’t operate that way). Nowadays, companies are doing the same thing by touting their AI strategy in their earnings reports.

Is it similar today? Well, I often say history doesn’t repeat itself, but it tends to rhyme. The hype surrounding AI may be justified as transformative technology, yet valuations still hold importance. What you pay for something determines the long-term return – there’s no disputing that. Also, history is rife with examples of initial market leaders whose competitive edge fades. No different from AOL, Yahoo!, etc.

Looking at the markets today, especially large US companies, we observe a pattern reminiscent of the Tech Bubble. The chart below illustrates the PE ratios at various points in time for the top 10 largest companies over the past 30+ years. The current top 10 are more expensive than they’ve been over 40 years.

This indicates that, much like during the Tech Bubble days, investors are disregarding valuations. However, this doesn’t necessarily mean those stocks will plummet tomorrow. Markets and bubbles can remain irrational for extended periods. The issue lies in never knowing when this irrationality will cease, or if stocks will simply stagnate for an extended period to align with their excessively high valuations.

Remember Blackberry? I recall that company vividly; I was inseparable from my Blackberry Curve – no self-respecting cool (and yes, I’m cool!) individual would be seen without one. Take a look at the graphic below, depicting the meteoric rise of Blackberry just as Android phones and iPhones were debuting, and consider what followed. Valuations matter.

So, where should you invest? Well, not to sound like a broken record, but diversification remains the key. While we do have funds in our portfolio that specifically target Tech/AI, other parts of the market offer reasonable pricing and attractiveness.

If we delve into the analysis below, it highlights the “Magnificent 7” stocks, which are the top stocks in the large-cap indexes. However, if we shift our focus to the next 42 companies (in terms of size), they collectively hold the same value, yet their sales and profits are double that of the top 7. This indicates that their valuations are much more favorable, which could bode well for stocks outside of the Magnificent 7 in the long term.

As often referenced in the media, the Mag 7 has reached unprecedented levels. These seven companies now constitute more than a third of the US large-cap market, a level of concentration not witnessed in 50+ years. Hint… that party didn’t end well half a century ago!

As always, we appreciate your trust in us with your hard-earned dollars. Remember, the only bad question is the one that isn’t asked.