The key feature of generalists talking the benefit of artificial intelligence is, ugh, the total addressable market (TAM) - the three most dangerous words in investing. Listen closely and you will hear glittering generalities and leaps of faith - miles long but only inches deep- Dougie Kass (@DougKass) May 22, 2023
I truly find it amusing having these "talking heads" with virtually no knowledge of AI talk confidentally but say absolutely nothing substantive about the impact of artificial intelligence on sources and beneficiaries of AI. Who they kidding? More tomorrow @realmoney @dougkass- Dougie Kass (@DougKass) May 22, 2023
As noted in the above tweets I marvel at how confident and flippant so many "talking heads" are about the likely application and road to profitability of artificial intelligence adoption -- without any real understanding of the subject and with knowledge bases miles long but only inches deep. This is nothing new -- for some reason market mavens are comfortable answering any question on any subject, despite the lack of depth of knowledge.
There is no better example than the subject of artificial intelligence, which has lifted the Nasdaq, in general and many of its largest constituents (e.g., Microsoft (MSFT) , Meta (META) , Apple (AAPL) , Nvidia (NVDA) , etc.) to levels that may not be justified by the possible reality of AI adoption. Indeed, and importantly, the possible bubble-like feature in the Nasdaq in 2023 has run deeply counter to its historic relationship to rising interest rates.
Note: In the last month, the 2-Year Treasury note's yield has climbed from 3.750% to 4.365% today, while large-cap tech has led the hit parade. In fact, 2-Year yields, ignored by the relentless climb in long duration tech equity prices, are higher nine days in a row -- arguably in a response to a shifting consensus on the Fed's willingness to keep its foot on the brakes and in anticipation of a flood of Treasury offerings after a debt ceiling deal.As I recently noted in Emotion Takes Over the Markets -- As 'TINA' Takes a New Form -- TINA ("there is no alternative") has taken on a new meaning this year:
"Today, TINA can arguably be associated with a small group of large-cap tech stocks - Microsoft, Meta, Apple, Alphabet, Nvidia, and Amazon. To many, there is no alternative to these six stocks, and their leadership is as conspicuous as the last narrow market advance in history...that of The Nifty Fifty.
The following chart underscores the remarkable year-to-date outperformance of the unweighted Nasdaq versus the equal-weighted Index. This NDX > NDXE spread is now +11% on the year, by far the widest spread over any 4.5 month period in the last 18 years."
I am not a quant, my background is in philosophy with an MBA in Finance -- it is not coding or, certainly not in AI where my sphere of knowledge is limited. But I am not a luddite -- as an investor, I accept and embrace investments in technology when I can find value and a "margin of safety." For example, in late 2022, I grew fond of the shares of Amazon (AMZN) , Alphabet (GOOGL) and Microsoft (MSFT) as demonstrated in my Daily Diary columns on Real Money Pro.
Note: I am now short MSFT and (QQQ) and not long any large-cap tech, in part because of what I am writing about Tuesday morning.
Instead, as I am want to do, I have done most of my AI research by talking to companies. In the last two weeks I have spoken to about 15 managements in a very broad range of industries on the subject of artificial intelligence -- how they are applying AI to their business, the impact of AI innovation on profitability, workforce, etc. Almost all of these companies replied the same.
Here are my observations and conclusions based on the last two weeks of these interviews:
* Profoundly deep regulatory, legal, ethical and employment policy management issues dominate the AI landscape (domestically and globally).
* There is limited clarity to nearly every one of the companies I spoke to with regard to the direction and timing of AI oversight and regulation, safety and otherwise.
* AI development is not "new," most of the companies have been working to apply AI to their businesses for years.
* The companies view a safe and smooth implementation of AI as likely to be gradual and intermediate term -- and not a near-term phenomenon.
* The regulatory/legal issues, in particular, are bound to be rapidly changing, hold deep and binding consequences on their business models -- but the terrain is still unclear.
* There will be a significant displacement of workers -- representing a serious ethical and economic issue.
* The threat of misinformation -- with broad consequences -- is a constant fear in the minds of the company managements I interviewed.
* And so is the fear, on the part of my company contacts, that our politicians, as contrasted to the rapidity of AI innovation, are slow moving and could easily screw up/adversely influence AI penetration through their likely governance surveillance, recommendations and oversight.
* Perhaps making matters worse could be the need for international oversight -- complicating an already tangled issue of governance.
While I recognize every new investment era starts with a "new thing" I also now recognize, through my interviews, the very complicated nature of the subject of AI -- its implementation and company/industry ramifications as well as the possible existential risks associated with AI adoption.
Takin' It to the Streets
* With an assist from "Uncle" Bob Farrell
You don't know me but I'm your brother
I was raised here in this living hell
You don't know my kind in your world
Fairly soon, the time will tell
-- Doobie Brothers, Takin' It To The Streets
As a practicing investment manager I have been influenced by the legendary Merrill Lynch technician Bob Farrell, who has offered some wise lessons on investing. As it relates to AI investing and the boisterous and the narrow market leadership of the Nasdaq, six of his lessons -- maybe we can call them label warnings are more appropriate -- stand out to me in the current market backdrop:
Lesson #2. Excesses in one direction will lead to an opposite excess in the other direction.
Translation: Markets that overshoot on the upside will also overshoot on the downside, kind of like a pendulum. The further it swings to one side, the further it rebounds to the other side. The chart below shows the Nasdaq bubble in 1999 and the Percent Price Oscillator (52,1,1) moving above 40%. This means the Nasdaq was over 40% above its 52-week moving average and way overextended. This excess gave way to a similar excess when the Nasdaq plunged in 2000-2001 and the Percent Price Oscillator moved below -40%.
Lesson #3. There are no new eras - excesses are never permanent.
Translation: There will be a hot group of stocks every few years, but speculation fads do not last forever. In fact, over the last 100 years, we have seen speculative bubbles involving various stock groups. Autos, radio, and electricity powered the roaring 20s. The nifty-fifty powered the bull market in the early 70s. Biotechs bubble up every 10 years or so and there was the dot-com bubble in the late 90s. "This time it is different" is perhaps the most dangerous phrase in investing. As Jesse Livermore puts it:
A lesson I learned early is that there is nothing new in Wall Street. There can't be because speculation is as old as the hills. Whatever happens in the stock market today has happened before and will happen again.
Lesson #4. Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways.
Translation: Even though a hot group will ultimately revert back to the mean, a strong trend can extend for a long time. Once this trend ends, however, the correction tends to be sharp. The chart below shows the Shanghai Composite ($SSEC) advancing from July 2005 until October 2007. This index was overbought in July 2006, early 2007 and mid-2007, but these levels did not mark a top as the trend extended with a parabolic move.
Lesson #5. The public buys the most at the top and the least at the bottom.
Translation: The average individual investor is most bullish at market tops and most bearish at market bottoms. The survey from the American Association of Individual Investors is often cited as a barometer for investor sentiment. In theory, excessively bullish sentiment warns of a market top, while excessively bearish sentiment warns of a market bottom.
Lesson #6. Fear and greed are stronger than long-term resolve.
Translation: Don't let emotions cloud your decisions or affect your long-term plan. Plan your trade and trade your plan. Prepare for different scenarios so you will not be taken by surprise with sharp adverse price movement. Sharp declines and losses can increase the fear factor and lead to panic decisions in the heat of battle. Similarly, sharp advances and outsized gains can lead to overconfidence and deviations from the long-term plan. To paraphrase Rudyard Kipling, you will be a much better trader or investor if you can keep your head about you when all about are losing theirs. When the emotions are running high, take a breather, step back and analyze the situation from a greater distance.
Lesson #7. Markets are strongest when they are broad and weakest when they narrow to a handful of blue-chip names.
Translation: Breadth is important. A rally on narrow breadth indicates limited participation and the chances of failure are above average. The market cannot continue to rally with just a few large-caps (generals) leading the way. Small- and mid-caps (troops) must also be on board to give the rally credibility. A rally that lifts all boats indicates far-reaching strength and increases the chances of further gains.
Artificial intelligence and superintelligence is growing exponentially and likely to be more powerful than almost any other technology adopted in the past. But, a "healthy" relationship between technology and AI tools with society is more complicated than many believe.
Guard rails, through oversight, is a necessary ingredient to broader AI adoption given the numerous and obvious existential risks. It is generally agreed that government agencies, or even a global surveillance regime in charge of audits, compliance with safety standards, etc., will take an important role in AI industry oversight, which will slow down the process of adoption and could create a less profitable road than is generally assumed.
Despite the steady rise in interest rates over the last four weeks, the shares of large-cap tech have been the beneficiary of AI speculation in 2023 -- for the reasons detailed in this missive -- that outperformance could be challenged in the near term.
In the weeks ahead I will communicate more details on my research on AI.
But, for now, the exuberance surrounding AI, as manifested in the outsized performance of a handful of large-cap tech stocks, might die down in the reality of the existential risks associated with AI adoption and governance:
Google Search Trends.
Makes one go hmmmmm doesn't it?
Will only look obvious in hindsight... pic.twitter.com/wpMUrDQ0ih- Heisenberg (@Mr_Derivatives) May 23, 2023
Additionally, as Bob Farrell has taught some of us, history provides good investing lessons.
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(This commentary originally appeared on Real Money Pro on May 23. Click here to learn about this dynamic market information service for active traders and to receive Doug Kass's Daily Diary and columns from Paul Price, Bret Jensen and others.)