“The market is wrong.” A senior portfolio manager at my old firm made this adamant statement in response to learning that he was being moved off of the portfolio he had been managing for more than a decade. His portfolio was not keeping pace with the market, which, in this particular case, was defined as the S&P 500. He needed to add more technology stocks in his portfolio to boost the return and be more aligned with his benchmark. He refused because he believed those stocks were in a bubble and it would be ugly when that bubble burst. Senior management’s response was to do what they had done before with experienced portfolio managers, “promote” him so that he no longer had day-to-day investment decision-making responsibility.
I know what you are thinking: In hindsight that proved to be a huge mistake, and this gentleman proved to be correct. Yes, but unfortunately for him, this conversation took place in early 1998 – two full years before that dot-com bubble finally burst. In the investment business there is little difference between being early and being wrong.
Are we in an AI bubble? Late last week I took an Uber home from the Atlanta airport after being gone several days. The very friendly driver asked what I did for a living. I hate that question, because it usually leads to a second question that isn’t really a question but a statement that the questioner wishes for me to reaffirm.
In this case, my Uber driver asked me what I thought about the valuations of AI companies. Fortunately for me, this gentleman didn’t even wait for my response before telling me the answer. According to my Uber driver, AI is wonderful technology but it is not the end game, they want to create actual human-level intelligence, which they will never do, so these stocks are all in a bubble that is going to burst and cause huge financial damage.
I never responded to anything the gentleman said, which turned out to be fine because he didn’t stop talking long enough for me to get a word in even if I wanted to. He was just as certain about us being in a bubble as that senior portfolio manager was all those years ago. He is even more wrong.
As Mark Twain supposedly said, “History doesn’t repeat itself, but it often rhymes.” We are not in the same place today that we were in the 1990s, but there are certainly similarities. AI is an exciting new technology with huge potential, much as the internet was 30 years ago.
However, the internet came at a time when value investing was king. Many of the internet startups were staffed by IT professionals who had found themselves unemployed when the tech giants of the day had massive layoffs in the early 1990s, while the AI movement came after a decade of large technology firms already dominating stock market returns. Most internet companies went public with little more than the promise of having “.com” at the end of their names, whereas AI has largely been driven by already established firms such as Nvidia and Microsoft.
AI has immediate productivity-boosting capabilities while the internet had potential. As a result, AI revenues have grown as fast, if not faster than, most of the stocks. This means that thus far there has been far less speculation than at the same moment in the 1990s. This is not a simple repeat of history, although there are lessons to be learned.
The one thing that drives all bubbles is human psychology. That has not changed, which means we likely will have an AI bubble. It is our nature to overdo; we overreact to news both good and bad, and we do it on repeat. However, if that does happen with AI, we are much more likely in 1997 or 1998 as opposed to 2000. Bubbles don’t burst when Uber drivers are talking about being in a bubble; they burst when everyone believes it is a brave new world.
Two years after that uncomfortable meeting with the senior portfolio manager, I had another one. This time it was me stepping out on a limb and suggesting that our current star portfolio manager was about to blow up. This portfolio manager had just won a “Manager of The Year” award from Morningstar and had appeared on Louis Rukeyser’s “Wall Street Week,” where he infamously suggested that valuations no longer mattered. That was February of 2000; the bubble burst in March, and thankfully for my career, I was proven correct. There is little difference between being early and being wrong, and it is too early for bubble warnings.
Warm regards,
Chuck Osborne, CFA
