If you speculate, don’t forget to sell

Much attention is being given to AI and its projected effects on economic growth and social behaviour. Looking at AI through an investment prism, is its parabolic speculative price a bubble that will burst, or just the beginning of a sustainable cycle? Google gave the first presentation on the benefits of AI as an innovative technology some 10 years ago, but the buying frenzy in stocks with exposure to AI development and production is recent. Just a few hours of study of the subject leads to the conclusion that, in time, AI will dramatically change the way we do business. This can be safely assumed as a given. But how and when to invest?

If we look at the price of shares for the US company Nvidia as a proxy for the growth of AI, we see that the fear of missing out has driven many speculators to buy shares to make a speculative return.

In 1720, Isaac Newton invested all his capital into what is now known as the South Sea Bubble, following a red-hot tip from his friends and a sharp rise in the share price. He was further tempted to take profits after a huge gain in the share price, expecting the price to eventually fall, only to find that the price continued to rise. He was tempted to buy in again, only this time to lose all his capital when prices fell as sharply as they had risen and the bubble burst. The bubble of a supposedly invincible network of companies produced a great crash.

I am not suggesting that the technological advance in AI will end in a Ponzi scheme; I am simply asking whether the vehicles that speculators and investors have used to buy into the industry are sustainable, given the parabolic rise in share prices and valuation multiples. There are many lessons to be learned from the South Sea Bubble, one being that if you speculate in a stock at 24 times sales multiple, don’t forget to sell while you have profit. Have a clear price target and exit strategy before buying.

Since 2008 and money printing by the Federal Reserve and other central banks, a “casino” has been created in which speculators prefer to rent stocks for a quick profit, rather than investing over the long term for appreciation of capital and dividend payments. They are drawn in by the momentum of a sharp increase in price, but while Nvidia has a large competitive advantage, there is still only so much market to sell to!

We have recently seen the collapse of bubbles in Meme stocks and SPACs without any compelling economic investment case to sustain sharp price increases. Technology advancement has a deflationary effect on economic growth. We need look no further than cloud technology, which was started by a few large players who engaged in a competitive price battle, putting downward pressure on earnings and prices. The consumer was the winner. The efficiency of technology allows costs to be cut, but often at the expense of labour. Cognitive bias is a real danger. Many AI solutions tend to interpret the aggregate middle of the road outcome to avoid offending in an increasingly diverse and sensitive marketplace.

Jeremy Blatch TEP
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