As we near the midpoint of 2023, the pervasive influence of artificial intelligence (AI) becomes impossible to overlook. From self-driving cars to smart speakers, from facial recognition to natural language processing, AI is everywhere — and has been for a while now, even when we were not calling it AI. This is not just a consumer phenomenon. Businesses across all sectors are leveraging AI to improve efficiency, productivity, innovation, and customer satisfaction. For example, AI can help manufacturers optimize their production processes, reduce waste and defects, improve quality and safety, and enhance customer satisfaction. According to a recent report by McKinsey, AI could add up to $13 trillion to global GDP by 2030.1
But what does this mean for investors? Companies that can harness the power of AI to gain a competitive edge or disrupt existing markets can generate huge returns for their shareholders. Think of Amazon, Google and Netflix, some of the most successful and influential companies of our time, all driven by AI. On the other hand, AI also poses significant challenges and risks for investors. Companies that fail to adapt to the changing landscape or fall behind in innovation can lose market share, profitability, and relevance. Think of Kodak, Blockbuster, Nokia and Sears, some of the most tragic examples of corporate decline in the face of technological change.
As AI becomes more pervasive and powerful, its impact extends beyond companies and affects how financial markets behave and how investors make decisions. For instance, AI can amplify market trends and volatility by creating feedback loops and herd behavior among algorithmic traders and robo-advisors. AI can also distort market signals and valuations by generating fake news and manipulating data and sentiment. AI can even challenge the very notion of human agency and rationality by influencing our preferences and biases through personalized recommendations and nudges (think of your Instagram and Facebook timelines).
Speaking of nudges, the U.S. stock market has nudged higher this year despite the debt ceiling drama, bank failures, and geopolitical tensions. As of June 20th, 2023, the S&P 500 index gained 15.2% year-to-date while the Dow Jones Industrial Average rose 3.9%. These numbers hint to the lack of breadth and diversity in the equity markets. A closer look reveals that most of the gains have been driven by a handful of large-cap tech stocks that are heavily invested in AI. The Nasdaq 100 Index has soared 38.3% year-to-date. In contrast, many other sectors and industries have substantially lagged or even declined in value. For instance, the Equal Weighted S&P 500 Index has risen only 5.0% on the year.
This divergence partly reflects the market’s view of the growing gap between AI winners and losers. Winners leverage AI for customer, shareholder, and societal value. Losers are disrupted or fail to capture AI benefits. As investors, we need to be aware of this gap and position ourselves accordingly, while also avoid getting caught up in the mania.
Dotcom Déjà Vu?
While AI will almost certainly be a transformative technology, it is worth mentioning the last time the performance gap between the NASDAQ and the Dow was this wide. Investors in 1999 probably felt like they were living in two different worlds. That year, the NASDAQ surged 85.6% due to the Dotcom frenzy, while the Dow had a modest 25.2% gain as traditional companies prioritized “profits” over “clicks.” This resulted in a staggering 60.4% difference between the two, the highest ever recorded. Amazon skyrocketed 969% and Yahoo grew 648% on the NASDAQ, while Exxon Mobil fell 14% and Coca-Cola dropped 11% on the Dow.
Sadly, the history of investing is littered with the wreckage of boom-and-bust cycles, and this era was a hallmark episode. In 2000, the Dotcom bubble burst and the NASDAQ plunged 39.3%, wiping out billions of dollars of market value. The Dow also fell, but only by 6.2%, cushioned by its more stable and diversified constituents. The difference between the two returns was again huge, but this time in favor of the Dow, by 33.1%. (For those interested, the Dow outperformed the NASDAQ by 36% over the boom-and-bust decade spanning 1997 – 2007, with the Dow rising 135% relative to the NASDAQ’s 99% gain.)
Cisco is a compelling case study on the significance of price even among “generational winners.” It experienced remarkable success and profitability during the Dotcom era, benefiting from the Internet’s rapid growth and product demand. Cisco’s revenue surged from $6.4b in 1997 to $22.3b in 2000, while net income rose from $1.6b to $2.7b. The company’s stock price skyrocketed from $8 to $80, making it the world’s most valuable company with a market capitalization exceeding $500 billion. However, Cisco’s valuation, with a price-to-earnings ratio of over 200, was based on unrealistic growth expectations and “irrational exuberance.” The company faced intense competition from rivals like Nortel Networks and Lucent Technologies, along with the telecom sector slowdown during the Dotcom bust. Cisco’s stock price plummeted from $80 in 2000 to $8 in 2002, losing over $400 billion in market value. Investors who bought at the peak lost over 90% of their investment. Despite strong revenue ($55 billion) and net income ($15 billion) today, Cisco never reclaimed its Dotcom peak price, even after 23 years of the growth many expected as they bid up the price in the late 1990s. Valuation matters.
Another Experiment in Anarchy?
Besides speculating on industry winners and losers and their appropriate valuation, AI carries significant implications for mankind. Coping with technological advancements is not a new challenge, as evident in the following quotes that remain relevant today.
- In 1964, the scientist Isaac Asimov wrote: “The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.”
- In 1996, Eric Schmidt, a co-founder of Google, said: “The Internet is the first thing that humanity has built that humanity does not understand, the largest experiment in anarchy that we have ever had.”
These quotes capture both the optimism and caution we should have when it comes to AI. For humanity, AI likely brings unprecedented opportunities…and challenges. For investors, AI is likely neither a blessing nor a curse. It is a powerful tool that we can use and invest in, wisely or foolishly. Let us not be fools.
Humans > Machines
I hope you find this commentary lacking my usual wit and levity because 90% of the preceding text was written in 15 minutes using Microsoft’s Bing AI tool. I asked it to analyze the writing styles of several of my prior commentaries and write a new one about artificial intelligence and the financial markets. I fed it ~10 prompts along the way, so it could sharpen its output to the points I wanted to make. As I (or more accurately it) wrote, unprecedented opportunities…and challenges. The potential for increased productivity in business applications are great, indeed. But, while AI can scour the internet for content, analyze data and help streamline operations, it falls short in replicating infinitely valuable emotional intelligence. My job is safe … for now.
All market data is sourced from Bloomberg unless otherwise noted.
1“The economic potential of generative AI: The next productivity frontier.” McKinsey Global Institute, McKinsey & Company, Sept. 2021.