I know we are past Halloween, but everyone seems to be scared of an AI bubble. It seems to be the only thing people can talk about in investing circles. So, are we in an AI bubble?
Of course we are, but that is not the right question. If one wants a useful answer, then she must ask useful questions. In the late 1990s I was part of an investment team that was running an asset allocation strategy, and the lead manager was convinced that we were in a technology stock bubble. Based on our work we moved away from large growth technology and went heavily into real estate; if we could have then time traveled forward a decade, he would have looked like a genius. Unfortunately, he made that call several years before the bubble burst.
In the meantime, people remember famous quotes from the era. Fed Chair Alan Greenspan famously warned of “irrational exuberance.” We all remember that, but do we remember that he said that in 1996, four years before the tech bubble burst? There was lots of talk about bubbles in the 1990s. NASDAQ, the home of most of the high-flying technology companies at that time, had more than a dozen corrections during the 1990s. (A correction is a drop of 10 percent or more.) Every single time there were people out there saying the bubble was bursting, and they were wrong every time.
What they were really saying then, and what many are saying now is, “I am not invested in the internet (AI today) and I’m relieved there is a correction because I have missed out on all those returns.” They will continue to do that for as long as they can stand it. Then, the very same people will ultimately give in to their fear of missing out (FOMO) and change their tune.
One of my colleagues at Invesco during that era had great success investing in technology firms. He declared that valuations no longer mattered, and once told me that “small value” was an oxymoron. His fund then dropped 49 percent in value in 2001. The small value category was the best place to be in the market for the next decade. He lost his job, but not before demonstrating how people talk before a bubble bursts.
The right question is not whether we are in an AI bubble, but where are we in the inflation process of that bubble? The answer to that question is that we are far closer to the beginning than we are to the end. How do we know? Because everyone keeps talking about being in a bubble. When that stops and they start saying things like “this is a new world,” “valuations don’t matter,” or “every other investment makes no sense,” that is when the bubble is about to burst.
Warren Buffett did not go on the internet bubble ride, and you don’t have to go on the AI ride. However, if you choose that path, you had better be sure that you are as psychologically strong as Buffett. During that time articles were written describing how he was washed up and could no longer succeed in the new world. He didn’t care, and he came out just fine. Likewise, had my colleague not been fired and been allowed to ride out the decade of the 2000s, he would have been fine as those tech stocks did ultimately pay off. He was not allowed to be out of sync with the market that long; few investors can. That is really Buffett’s secret: After a good ten-year run in what today would be called a hedge fund, he bought Berkshire Hathaway and fired his clients. He can ride through long periods of being out of sync.
Most of us have to live somewhere in the middle. AI is a bubble and eventually it will burst, but that is most likely years away. Instead of guessing, we believe that one should remember that it is better to be an owner of companies than a trader of stocks, and diversification is our friend. There is no law that says one can own only AI or energy but not both.
Finally, at the end of 2002 I left Invesco to start Iron Capital. Shortly thereafter my girlfriend (now wife) and I were at a dinner party where one of the other couples asked, “Do you think we are in a housing bubble?” That was approximately 2004, and we were, but that was the wrong question…
Warm regards,
Chuck Osborne, CFA
