Last week, the technical deterioration in the US stock market was clear, but Nvidia’s
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An explosive earnings report saved the day. The tech giant’s results beat Wall Street’s expectations on every metric, leading to an upside for the company as well. There was nothing to complain about in that report. As a result, the PHLX semiconductor index SOX, which is a leader in artificial intelligence, rebounded sharply.
But just like the dot-com bubble of the late 1990s, the signs of overreach are clear. Still, I reiterate my view that there is much more room for the AI bubble to reach the “grand rise” stage.
This is how bubbles are created. Consider General Electric Company.
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It was one of the non-tech favorites of the late 1990s. Jack Welch, considered a superstar CEO at the time, required department managers to be number one or two in their line of business. Failure to meet these goals will result in the division being closed or sold.
Unable to produce numbers, the department head tried the old-fashioned method of financialization. GE would lend money to customers to buy its products, then send the money back and forth to inflate sales. This strategy worked so well that GE Capital was born. GE Capital financed anything that moved in order to achieve a top-two position in the industry. It wasn’t just aircraft engines, it was also emerging market loans and subprime loans. GE Capital grew larger than the industrial arm of the company and eventually collapsed. GE CEO Jeff Immelt announced the sale of GE Capital in 2014, and that portion was ultimately sold over the next two years.
It’s happening again. Instead of giving money to vendors, today’s tech giants buy stock in companies and shuttle the money back and forth to grow sales.Amazon.com Inc.
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The Anthropic investment and Nvidia’s CoreWeave investment are just two of the most visible examples of financialization. With today’s market focused on the prospects for achievable market and sales growth, tech executives, who are mostly paid with stock-based compensation, are looking to boost sales growth at all costs. I’m excited.
This isn’t going to end well, but it hasn’t yet. It’s still early days of the bubble.
Some concerns have also been raised about the concentration of US market indexes. These concerns are alleviated by two factors. Concentration was not at the crash in October 1929, but from 1931 he reached its peak in 1932. Moreover, the current episode of increase in index concentration is more moderate and less abrupt than the previous two instances.
Valuations are also more reasonable than the experience of the dot-com bubble in the late 1990s. The prices of technology and communications services stocks remain closely linked to business results.
But there are plenty of warnings about overreach to worry about. Amazon is replacing Walgreens Boots Alliance.
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Dow Jones Industrial Average DJIA.
Documented by SentimenTrader How being removed from the Dow Average is a contrarian buy signal on average, and how new stock additions tend to lag the market.
The last time this happened was in 2020, when Salesforce Inc.
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On behalf of ExxonMobil
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This was great for Exxon shareholders, but not so much for Salesforce investors. So this recent change in the composition of the Dow Jones Industrial Average may indicate that Amazon, and growth stocks in general, are falling behind the market.
read: Why Amazon and Uber investors want these stocks to stay out of the Dow
more: Here are 20 AI stocks poised to rise as much as 44% after Nvidia’s recent collapse
Virtuous cycle of AI
There is no doubt that AI will transform the way we work and improve productivity over the next decade. Even without the benefits of AI innovation, research by RSM’s Tuan Nguyen and Joseph Brusuelas shows that U.S. total factor productivity has soared, offset by productivity gains. This should encourage the Federal Reserve to overlook wage increases that outpace inflation.
During Nvidia’s earnings call, CEO Jensen Huang said the company is at a “tipping point” in demand for AI systems. Additionally, he added that NVIDIA’s latest results represent the first year of “his 10-year cycle of spreading this technology across all industries.”
Taken together, the productivity gains from AI, on top of current benefits, could trigger a virtuous cycle of non-inflationary growth in the U.S. economy. Such a scenario could lead to a huge AI-driven stock bubble in the coming years.
Things to be careful about
The market cycle is currently in the early stages of an AI-driven boom. Investor sentiment is inconsistent with the excesses seen in the top markets. As a reminder, here are some signs of dot-com era excess.
- Investors flocked to Mannesmann, a German conglomerate primarily known as a manufacturer of steel pipes, because it had a division that established Germany’s first mobile phone network. The company was eventually acquired by Vodafone for €190 billion, the highest acquisition price ever paid at the time.
- Holding conglomerate Hutchison Whampoa has become a darling of TMT (Technology/Media/Telecommunications) due to its exposure to telecommunications in one sector.
- Company presentations from different industries, such as mining or forestry, always include a section titled “Our Broadband Strategy.”
- The top was marked by a flood of low-quality IPOs. Remember all the services of B2B (business-to-business) and B2C (business-to-consumer) companies?
To be sure, some signs of froth are emerging, including examples of financial engineering to boost sales. The Wall Street Journal also recently reported on how teenagers are using custodial accounts to jump into the stock market.
Charles Schwab teen custody accounts rose from about 120,000 in 2019 to nearly 200,000 in 2022, according to Schwab figures cited by the magazine. Thanks to Schwab’s integration of TD Ameritrade, there will be another 300,000 in 2023. Other brokerages such as Vanguard, Fidelity and Morgan Stanley’s E-Trade have also reported a surge in custodial accounts in recent years.
The latest BofA Global Fund Manager Survey reveals that respondents are moving long into tech stocks. This may be a contrarian warning, but it may be premature. History shows that such overweight allocations can continue for years as long as the sector outperforms.
If I had to guess, the current AI-driven craze feels more like 1997-1998 than the dot-com era of 1999 and 2000. Investment theory is realistic and valid. Prices are just starting to go up. Advancement is not a straight line, but wait for real signs of bubbles before being cautious.
Cam Hui writes the investment blog Humble Student of the Markets and this article was first published. He is a former equity portfolio manager and sell-side analyst.
Also read: Ed Yardeni: Expect stocks to rise and inflation to fall in this ‘Roaring 2020s’ market
plus: U.S.-China tensions over Taiwan threaten to derail Nvidia and other tech giants