Speculative A.I. Melt Up – FOMO is Alive and Well
The 2023 stock market rally is built upon a speculative melt up of a handful of stocks
Speculative A.I. Melt Up – FOMO is Alive and Well
Executive Summary
The year to date return for the U.S. stock market has primarily been driven by a handful of stocks.
The S&P 500 is still over 10% below the high reached in January of 2022.
Returns coming from a handful of stocks is symptomatic of late cycle, bubble market activity.
Speculative investors quit buying NFTs to buy Meme Stocks, then quit Meme Stocks to by Crypto Currency, then quit Crypto Currency to buy Artificial Intelligence stocks.
They put the artificial in artificial intelligence.
In my opinion this is likely unsustainable. Reuters explained it today:
Reuters - U.S. Markets
Burry, famous for 'Big Short,' bought bearish options against S&P, Nasdaq 100
By David Randall and Saqib Iqbal Ahmed
August 14, 20234:39 PM CDT
“The S&P 500 (.SPX) is up roughly 17% for the year to date while the Nasdaq 100 (.IXIC) is up nearly 39% over the same period. Outsized gains in a handful of megacap companies such as Nvidia (NVDA.O) and Meta Platforms (META.O) have fueled much of the year's rally.”
The rally was kicked off by a mania over Artificial Intelligence. ChatGPT came into prominence early this year and public companies began to tout the benefits (and their to be determined improved capabilities and profits) in earnings calls. Leave it up to Wall Street to put the cart before the horse (see Bloomberg chart below). AI will be a major investment theme but the baby still hasn’t left the maternity ward.
Datastream put together the numbers as of the end of June (chart below). The S&P 500, pulling out the ‘AI Boom Stocks’ is roughly unchanged for the first 6 months of 2023. Normally when a new bull market takes hold the rally is broad based, and typically led by small cap stocks, this is not the case today.
Artificial Intelligence as an industry and capability is in its’ infancy. It has a long way to go before its’ impact is meaningful. This reminds me of the internet boom of the late 90’s where many amazing developments over the coming decade, but they took place after the initial hysterical bubble burst.
JP Morgan points out below that the largest 10 stocks in the S&P 500 have regained their 2021 market share of the S&P 500 Index but their contributions to earnings have continued to slide over the past 18 months. Prices are up but their earnings contribution is falling. I think that this price action is unsustainable.
Another note of caution is the relationship between interest rates and the NASDAQ (which is dominated by technology stocks). The Capital Asset Pricing Model outlines the relationship between stock prices and interest rates, low rates generally equate to higher stock valuations and vice versa. Below Crescat Capital and Bloomberg chart this dynamic. As rates go up prices go down. The red line is the 10 year Treasury inverted [the red line moving down is the 10 year treasury moving up). We see that in 2021 and 2022 as rates went up the NASDAQ struggled. In March this relationship was broken due to the Artificial Intelligence frenzy. Interest rates continue to move up and in my opinion I see tech stocks falling, returning to their normal relationship with interest rates.
Conclusion
In my opinion caution is warranted. Investors within 10 years of retirement should reassess their exposure to highly valued stocks within their portfolios.
LPL 474378-1
DEFINITIONS
10 Year Treasury Note and Yield – The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months and pays the face value to the holder at maturity. The U.S. government partially funds itself by issuing 10-year Treasury notes.
NASDAQ 100 Index - The NASDAQ-100 is a stock market index made up of 103 equity securities issued by 100 of the largest non-financial companies listed on the Nasdaq stock market. It is a modified capitalization-weighted index. The stocks' weights in the index are based on their market capitalizations, with certain rules capping the influence of the largest components. It is based on exchange, and it does not have any financial companies. The financial companies were put in a separate index, the NASDAQ Financial-100.
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