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Bank of America doesn't hesitate to speak of the birth of a new investment bubble on par with the Internet bubble, the Biotech bubble, Ark Invest stocks, bitcoin or GAFAs. While some AI-related stocks have the potential to deliver a growth rate in line with current market expectations, history tells us that most of them will not. As explained in a recent article by Research Associates, picking future AI winners is the equivalent to investing in Amazon, Apple and ADP in early 2000.
These three stocks are the only ones among the 40 biggest names in the technology sector at the turn of the century to have recorded double-digit performances in the 23 years since. Since ChatGPT 3.5 was released by Open AI in November 2022, companies deemed likely to be AI leaders in the coming years have seen their share prices significantly outperform the rest of the market.
In fact, a new term has emerged on Wall Street - "The Magnificent Seven", or the seven large-cap tech companies considered to be the likely AI winners. At the time of writing, these seven stocks account for almost 28% of the S&P 500's market capitalization.
Indeed, since the start of the year, the performance of the major US stock market indices has been heavily concentrated on a small number of stocks. As the chart below shows, 5 stocks are responsible for over 60% of the Nasdaq 100's gains in 2023. AI is a common denominator for these American market behemoths.
Source: Bloomberg
Many investors tend to see these stocks as the sole beneficiaries of the AI revolution, not only because of their ability to attract talent, but also because of their financial strength, which enables them to make huge R&D investments in their AI branches. This is an important difference from the dot-com bubble of the 2000s, when not only large-cap companies were riding the ".com" wave; indeed, numerous IPOs of Internet stocks had broadened the spectrum of available investment opportunities.
Should we deduce from the above that the best way to invest in AI is to be positioned in a very limited number of stocks? Are there other stocks and sectors that stand to benefit from this technological transformation?
Beyond the established players, a new generation of startups and innovators are making their way into the AI landscape. These smaller entities are pushing the boundaries of what's possible with AI. Their innovations, whether niche AI applications or revolutionary algorithms, position them as future nuggets. As investors look to diversify their portfolios, identifying these direct beneficiaries offers a roadmap for navigating the AI investment landscape.
Whichever path the investor decides to take, he must do so by implementing a diversified approach and adopting all necessary measures to avoid idiosyncratic risk. One way of doing this is to include ETFs in the portfolio. ETFs with exposure to the AI theme include BOTZ, the Global X Robotics & Artificial Intelligence ETF, and ROBO, the ROBO Global Robotics and Automation Index ETF.
2. The beneficiaries of innovation
The AI technology revolution also affects the businesses that adopt and implement this technology. From retail giants leveraging AI to create personalized shopping experiences to healthcare facilities harnessing AI for diagnostics, the spectrum of end-user companies likely to benefit is vast. Investments by these companies in AI-based software and infrastructure services will not only improve operational efficiency, but also redefine customer and workforce engagement paradigms.
From our point of view, the potential of AI is enormous, and we have probably entered a new era. Like the Internet, AI will revolutionize the business world and our daily lives. The history of financial bubbles tends to repeat itself. As was the case during the Internet boom, financial markets tend to pay very high valuation multiples for companies that seem best positioned to benefit from the new technological revolution.
Never before has a mega-cap traded on the basis of Nvidia's current multiple (nearly 45 times sales and over 100 times earnings). Looking at relative valuation ratios, like in the example below, with relative PEG - i.e. P/E compared with expected earnings growth rate, the S&P 500 technology index is trading at a valuation premium similar to that of the dot.com bubble. The potential for correction is therefore significant.
Source: Game of Trades