-
As the Magnificent Seven giants continue to gain ground, concerns about concentration in the stock market are growing.
-
A bursting of the AI bubble could mean a lost decade for the stock markets, similar to the end of the dot-com boom.
-
It is crucial for investors to diversify their portfolios to avoid losses if the bubble bursts, Richard Bernstein told Business Insider.
The hype about artificial intelligence continues to grow, and with it the fear of increasing concentration on the stock market.
Nvidia’s stunning fourth-quarter earnings boosted the company’s market capitalization by $267 billion on Thursday — more than the entire value of Netflix, setting a record for the biggest one-day gain ever.
As the Magnificent Seven concludes their latest earnings season, it is safe to say that AI trading is in full swing.
With such close leadership, however, analysts are warning of an AI-driven tech bubble reminiscent of the one two decades ago. Just like then, warnings are mounting that the latest bubble will also burst.
“The important thing to remember is that bubbles ALWAYS revolve around a new technology or a new development. This is a little different because so far… so far… it hasn’t led to any widespread new problems,” Richard Bernstein, president of Richard Bernstein Advisors, said in an email to Business Insider.
The bursting of the dot-com bubble ushered in a lost decade for the stock market.
From 1999 to 2009, the S&P 500 returned -1 percent per year, and the Nasdaq performed even worse at -5 percent per year (-6 percent per year for the Nasdaq 100).
“If someone had actually invested in NASDAQ at the peak of the tech bubble in March 2000, it would have taken them nearly 14 years to even break even,” Richard Bernstein Advisors wrote in a note last week.
Fortunately, according to the RBA, there is a simple solution to avoid the fate of investors in the dotcom era: diversification.
“It has never been wise to forgo diversification, and that is certainly true in a bubble phase. The key to future returns could be simple, basic diversification.”
The top six against the magnificent seven
In the last year of the technology bubble in 1999, the allure of Internet technology and its potential to revolutionize the economy caused some stocks to rise rapidly. The information technology sector of the S&P 500 delivered a total return of 103.76% that year, the RBA found.
Meanwhile, old economy stocks were outperformed by the technology sector, while the six other major sectors of the S&P 500 achieved an average return of 10.7 percent.
According to an RBA analysis, many investors believe that today’s “AI bubble” is fundamentally different from bubbles of past years because the leading mega-cap companies are “real companies” and not ones with high valuations that generate only low profits.
This is a misunderstanding, said Bernstein.
The six biggest tech titans in December 1999 – Microsoft, Cisco, Intel, IBM, Oracle and Qualcomm – were legitimate companies with solid financials and positive cash flow at the time. But when the bubble burst, none of these stocks quickly recovered to their previous highs. Cisco stock didn’t fully recover until 2019.
Today, the AI-fueled bubble and pandemic-induced excess liquidity have driven up equity valuations and led to highly speculative and concentrated market leadership.
The stocks of the “Magnificent Seven” – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla – currently make up about 29% of the S&P 500. Bernstein said that while some of these names have shown solid fundamental growth, the growth is not exceptional compared to many other companies.
“Currently, there are about 140 stocks in the equity markets of the G-7 countries (US, Canada, Germany, Japan, France, UK and Italy) that are forecast to grow earnings by 25% or more next year. Most importantly, only three of the ‘Magnificent Seven’ pass this test, and the fastest growing of the ‘Magnificent Seven’ ranks only 25th,” he said in the statement.
Diversification is key
Bernstein reiterated that investors need to diversify their portfolios to avoid future losses that dragged down portfolios in the years following the dot-com bust. Fortunately, the range of solid investments outside the largest stocks represents a “once in a lifetime” opportunity, the RBA argued.
“If your view of the world turns out to be wrong, then you have something that is likely to perform better in that unforeseen scenario. So there should always be a spare tire in the portfolio in case you are wrong,” he told Business Insider.
He also distinguished between “economic opportunities” and “investment opportunities”.
“Technology always changes the economy. My favorite technology that significantly changed the economy was the light bulb because it turned the economy into a 24-hour economy,” he said. “AI will change the economy, but that doesn’t mean that investing in the AI stocks that are accepted today will prove profitable in the long run.”
Read the original article on Business Insider
