The Newest 'New Era' Investment Mania

All investment manias blow up eventually... The Internet changed our lives – but it also wrecked a lot of investors... The newest 'new era' investment mania... ChatGPT's take on artificial intelligence... Get ready for companies to add 'AI' to their names... 'The tipping point of a new computer era'... Can you afford to wait 190 years for this bet to pay off?... Value traps vs. growth traps...

Over the years, I (Dan Ferris) have dealt with my share of 'new era' investment manias...

I've seen them come, briefly minting hordes of new millionaires as the boom times roll... and then go, wiping out a lot of those same folks in the bust that inevitably follows.

And through it all, I've learned one important thing...

All investment manias blow up eventually – even if the underlying premise is sound.

You see, to investors, it doesn't matter whether the premise is sound. In the end, it's about how many people believe it – and how expensive the bets become in the financial markets.

You know what I'm talking about if you've invested since at least 1998. That's when the dot-com mania really got going...

The dot-com boom hailed the expansion of the Internet as a new era. And by the late 1990s, everybody knew it would change how we lived, worked, and did basically everything.

Of course, the underlying premise was correct...

It really did change how the world does business. It really did change the way we shop for everything from groceries to automobiles to medical and legal services. And heck, more than two decades later, it's still evolving and changing the way things happen every day.

That's a big reason why Internet-based businesses like Alphabet (GOOGL), Amazon (AMZN), and Meta Platforms (META) are now among the top 10 U.S.-traded companies in terms of market cap.

Their fundamental services – online search, e-commerce, and social media – are available 24 hours a day, 365 days a year. And they're embedded seamlessly in billions of lives.

But for many folks, the Internet era was also a lousy investment proposition...

Back then, everybody in the market was convinced that the Internet would change everything. So every stock even remotely connected to it was priced for perfection.

The Nasdaq Composite Index became the poster child for the Internet era...

The tech-heavy index surged more than 250% from October 1998 through March 2000. That incredible 17-month run minted hordes of new millionaires.

But then, the bubble popped...

The Nasdaq plummeted 78% through its October 2002 bottom. And many individual stocks suffered even worse – if they even survived at all.

Like all investment manias, the ensuing bust wiped out many folks who got rich quick just months earlier.

You might not realize it, but the new era of the Internet also gave rise to a related investment mania...

Housing.

During the housing bubble. a lot of people made a lot of money flipping houses. And since housing prices had never fallen before, everyone believed that they never would.

You know what happened next...

The housing bubble blew up. And before long, we were all living through the great financial crisis – complete with its massive bailouts and the big financial-institution failures of Bear Stearns, Merrill Lynch, Lehman Brothers, Washington Mutual, and Countrywide Financial.

Believe it or not, the underlying premise of the housing bubble wasn't completely wrong...

Housing prices did fall from 2006 to 2012 – so it was wrong to believe they couldn't fall. But since early 2004, when the investment mania in housing really got crazy, the S&P/Case-Shiller U.S. National Home Price Index has more than doubled.

That's great news for anybody who bought a house with a low-cost, fixed-rate mortgage and had the means to hang on to it for a long time. But with interest rates now at their highest level in 15 years, those days might be gone for good.

Whether the underlying premise of the mania is true or not is less important than the idea's popularity...

Once again, the real damage of the housing bubble stemmed from the fact that everybody in the financial markets believed that home values couldn't fall because they never had before.

But then they did.

Many folks made that bet at the worst possible time. And they got wiped out.

That brings us to the investment mania in the stock market in recent years...

In fact, it was a bubbling cauldron of multiple overlapping manias – large-cap growth stocks, risky technology stocks, clean energy, special purpose acquisition companies, cryptocurrencies, "meme stock" short squeezes, and speculative option-buying.

Most of those bubbles have since burst.

Sure, the fears of higher interest rates and the 2022 bear market (which I don't believe has ended) have cooled 2021's speculative fever. But the cauldron is still hot enough to cook up another investment mania...

By now, you likely know that the newest 'new era' investment mania is artificial intelligence ('AI')...

We've already talked about AI over the past couple of Fridays, of course. But when everyone else is doing the same thing, it's important for me to help you get the full story...

Like the Internet investment mania, AI is very powerful. And it's virtually guaranteed to change the way we live, work, and do basically everything.

If you want to know why, just ask it. That's what I did this week...

I asked the popular AI platform ChatGPT why so many people are convinced that this technology will change the way we live and work. It gave me a list of seven reasons...

1. Automation and Efficiency
2. Advanced Decision-Making
3. Enhanced Personalization
4. Improved Customer Service
5. Scientific and Medical Advancements
6. Innovation and Economic Growth
7. Addressing Global Challenges (climate change, poverty, and health care)

To be fair, ChatGPT was also sympathetic to us mere mortals...

It expressed concern about job displacement. And it also noted potential ethical considerations – including privacy issues, bias in algorithms (which is hilarious, since ChatGPT is filled with bias), and potential misuse.

I wonder if ChatGPT could help us predict the next stage of this investment mania...

Get ready for companies to start adding 'AI' to their names...

In the heyday of the Internet era, adding ".com" to a company's name would send the stock skyward. And a similar (but much smaller) mania took hold in 2017, when companies made their stock prices double or more by adding "blockchain" to their names.

A few publicly traded companies already include AI in their names. And just like at the height of the Internet investment mania, their stocks are priced for perfection today...

For example, C3.ai (AI) is valued at roughly $3.7 billion, burns cash, and trades for 16 times sales. And yet, its stock is up about 200% since January 1.

SoundHound AI (SOUN) is valued at around $630 million, also burns cash, and also trades for 16 times sales. It's only up around 65% since January 1.

Of course, all sorts of large-cap companies are increasingly associating with AI as well...

The list includes the three Internet-based businesses I mentioned earlier – Alphabet, Amazon, and Meta Platforms. It also features other popular, tech-related names like Microsoft (MSFT), Apple (AAPL), Tesla (TSLA), Micron Technology (MU), and Nvidia (NVDA).

Now, I'm not saying all these stocks are thriving so far in 2023 just because of their ties to AI. After all, they're tech stocks in a still-tech-hungry world. But it isn't hurting them, either.

The largest companies on that list are all up between 35% and 50% in 2023. And some of the others are up even more. That's a massive amount of added market value in roughly five months.

As my colleague and Digest editor Corey McLaughlin noted earlier this week, Nvidia became the latest member of the "$1 trillion market cap" club on Tuesday. It has since dropped slightly below that level – but it's only a matter of time before it bubbles up above it again.

As if to tempt fate, Nvidia co-founder and CEO Jensen Huang is raving about its ties to this new investment era...

Most recently, Huang gushed about AI's potential at the Computex international computer expo in Taiwan on Monday. He believes the technology is making the job of computer programmer obsolete...

The programming barrier is incredibly low. We have closed the digital divide. Everyone is a programmer now – you just have to say something to a computer.

If you're like Huang and think the key pillar of a high standard of living is data science, you're misguided. Try creating a high standard of living without ammonia (for fertilizer), cement, plastics, steel, and the fossil fuels that make all that stuff possible. You can't do it.

But Huang isn't totally wrong...

That's how technology works. It allows us to be more productive.

Sure, some folks get left behind. But the overall effect of technology is greater productivity. And in turn, that leads to greater wealth creation for (almost) everyone.

Huang then went all in on AI. He predicted that it will change the whole world very soon...

The rate of progress, because it's so easy to use, is the reason why it's growing so fast. This is going to touch literally every single industry.

It's "easy" and "fast" – and it will "touch literally every single industry."

That's a breezy attitude. It's exactly what folks say at investment-mania peaks. It clearly labels this moment as bubblicious for AI.

But Huang still didn't seal his company's fate as the poster child of the AI investment mania until he said...

We have now reached the tipping point of a new computing era.

Yes, Huang really used the word "era" as if he knew I was going to write this Digest today. Wait a minute... maybe Nvidia's AI is already infiltrating my mind. Where the heck did I leave my tinfoil hat?

But seriously, again...

I'm not saying Huang is wrong. He's probably right. We are likely at the "tipping point" in the future of AI today. I'm just saying that whether he's right or wrong doesn't matter.

What matters for investors is that absolutely everybody agrees with him and has already concluded that no price is too high for Nvidia's stock. It's a classic investment mania.

I know I shared this comparison last week, but it's worth repeating again today...

Nvidia is the Cisco Systems (CSCO) of this investment era.

Cisco was the flagship stock of the Internet boom. And Nvidia is the flagship stock of the AI boom. Cisco makes Internet "plumbing" (switches and routers). And Nvidia makes AI "plumbing" (computer chips, graphics cards, and more).

And of course, as I said last Friday, Cisco eventually traded for about 200 times net profit at its 2000 peak. And Nvidia currently trades at just shy of 190 times net profit (as of yesterday's close).

If you could buy the whole company today – which would cost you roughly $970 billion, by the way – it would take you 190 years to get your money back.

I don't know about you, but I don't think I'll still be living 190 years from now. Maybe an AI platform could buy the company. It has a better shot of surviving until the year 2213.

If the company doubled its trailing 12-month net profit... then doubled it again... then doubled it again... it would be trading at between 20 and 25 times earnings.

That's still not cheap. But it's not 190 times, either.

Do you think it's likely that Nvidia will double its net profit once over the next few years? What about twice? And dare I ask if you think it will happen three times?

If you don't... you can't own the stock.

To own Nvidia shares today, you must be 100% certain that its net profit will rise eightfold very soon...

I wonder if any company in history has experienced such a rapid rise in net profits.

So my point is...

AI could live up to its vast promise in the years ahead. But for an investment in Nvidia at this price to pay off for folks, the company's net profit will need to catapult higher like never before.

Stocks like Nvidia trade at exorbitant multiples because the bulk of investors assume the companies will keep growing at high rates for a long time. It's a lot like how folks expected housing prices to just keep growing during the housing bubble – except they didn't.

Indeed, Nvidia's revenue grew 72-fold from around $375 million in 2000 to nearly $27 billion last year. Investors were rewarded, too. The stock became a 650-bagger (and then some) from its October 2002 bottom of less than $0.60 per share to its recent high of more than $400 per share.

But as I pointed out last week, Nvidia hasn't grown in recent years. Rather, its business is shrinking...

The company's trailing 12-month revenue has declined in each of the past three quarters – including the most recent one. It looks more like an expired growth story than anything else.

Now, to be fair, Nvidia's management team claims AI will change the recent trend. It says the company's second-quarter revenue will top $11 billion – about 52% higher than the most recent quarter.

If management is anywhere near right, I suspect this "new era" investment mania isn't over yet. Enough hope-and-dreamers will prop up Nvidia's stock to help it maintain its Cisco-Internet-investment-mania-like peak valuation for a little while longer.

But eventually, Nvidia shareholders will get the rug pulled out from under them. It happens in every investment mania – even if the underlying premise is sound.

That's perhaps the only certainty in this whole episode. It's virtually impossible for Nvidia to meet the expectations that are clearly and irrefutably baked into its current share price.

I'm not the only person who's urging folks to stay far away from the AI investment mania, either...

Herb Greenberg, our friend and an editor at our corporate affiliate Empire Financial Research, seems even less convinced of AI's potential. And like me, he has lived through his share of investment manias...

Before joining Empire Financial Research in October 2021, Herb spent more than four decades as a financial journalist. He worked at some of the country's leading newspapers, websites, and broadcast media.

On Wednesday, Herb wrote about the AI-related investment mania in the free Empire Financial Daily e-letter. And his warning sums up my thoughts perfectly...

When this stuff reverses, it's always brutal.

It happened with the dot-com bust. It happened with the housing bust. It happened with the bubbling cauldron of overlapping investment manias in the stock market in recent years.

And with the AI investment mania, we have no reason to believe it won't be brutal again.

Before long, Nvidia will likely become one of the worst types of stocks for investors...

A "growth trap."

Everybody has heard of "value traps." Most folks just think of them as cheap stocks that continue to get cheaper.

Asset-management firm GMO defines a value trap as "a company that disappoints on revenues in a given year and also sees its future revenue growth expectations fall." But no matter how you define the term, their existence is a standard criticism of value investing.

Value traps exist – and they're no fun. But there's a lot more to it, as a recent GMO research report shows...

The authors studied value strategies since 1996. And they concluded that in any given year, roughly 25% of the cheapest half of the stock market is made up of value traps.

Ouch. That sounds bad for value investors like me. But hang on a minute...

The authors also found that growth stocks are just as likely to fulfill their definition of a value trap as value stocks.

In other words, the entire market – from the cheapest stock to the most expensive stock – is filled with traps of both the growth and value variety. And anybody who criticizes value investing due to the existence of value traps is only telling you half the story.

Nobody wants to invest in a trap of any kind. But there's no such thing as a stock-picking strategy that never makes a mistake. So inevitably, we all buy into traps now and then.

That's why we use risk-management tools like proper position sizing and stop losses. They ensure that we won't get too emotional and hang on to the traps longer than we should.

But the thing is, growth traps are worse – by a lot...

GMO found that value traps have underperformed value stocks by 15.5% per year since 1996. That's bad.

But growth traps have underperformed growth stocks by 22.9% per year. That's worse.

GMO's findings were more nuanced than that. But at a minimum, they show that growth stocks hurt investors a lot worse than the more expensive half of the market when they go bad.

That makes sense. After all, as GMO explained...

While value companies are capable of disappointing investors, and any company that disappoints will generally underperform, when a growth company disappoints, it means not only that their fundamentals are worse than expected, but that they are less worthy of being considered a growth stock in the first place.

Since growth stocks trade at a premium to the market because investors believe they will grow strongly in the future, an event which calls that future growth into question is likely to be particularly painful since their valuation premium deserves to fall.

For our purposes here, the basic point is a simple one. Value stocks and growth stocks are basically equally likely to disappoint in a recession and when growth stocks disappoint, they are generally going to be punished a lot more.

In short, value stocks remain value stocks even when they disappoint – but growth stocks cease to be growth stocks when they disappoint.

That fact alone costs investors far too much money. They tend to place exorbitant valuations on growth stocks, believing that much higher levels of revenue and earnings will justify the expensive price tag one day – even if it's 190 years from now.

Even if the underlying premise is sound, that is how investment manias blow up.

New 52-week highs (as of 6/1/23): Apple (AAPL), Cintas (CTAS), Dassault Systèmes (DASTY), Meta Platforms (META), Palo Alto Networks (PANW), Invesco S&P 500 BuyWrite Fund (PBP), Pure Storage (PSTG), ProShares Ultra QQQ (QLD), ProShares Ultra Technology (ROM), and Spotify Technology (SPOT).

In today's mailbag, some subscribers wrote in about the debt-ceiling deal... and we're sharing more of your thoughts on if we're in a recession (and the price of cherries). Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com. Following this weekend's Masters Series essays, we'll pick up the "recession or not?" discussion on Monday.

"After seeing the statement in Thursday's Digest, 'will cut discretionary spending... to $12 billion less than current levels by 2024,' I understand why some conservative legislators balked at signing it.

"One trillion dollars is a thousand-billion dollars. On the $32 trillion debt, that comes down to 0.0375%. Even the $2.1 trillion cuts over six years comes to 6.56% or 1.09% per year.

"It's like paying off your credit card by paying the minimum each month." – Flex Alliance member Ronald K.

"I'm 75 and happily retired. That being said, I'm old enough (unfortunately) to remember when a McDonald's hamburger was 15 cents (the early '60s). Today, that same burger is $2.49. I can't even imagine how a family of four can go out and spend $50 or more for a nutrient-empty, fast-food 'meal.'

"My son is on the board of directors for a food bank in Fairfax County, Virginia. The Area Median Income (AMI) is $134,000 for a family of four. Even with that level of income, the food bank has seen demand triple over the last two years. In addition to food, the things most in demand are disposable diapers and paper goods [like toilet paper].

"I was a municipal bond trader most of my career. I've seen how bad things can get and for how long it can last. In my opinion, we are only seeing the tip of the iceberg for inflation. I fear that this is not going to end well for many people in this country.

"Thankfully, I've had some of the people at Stansberry (Dan Ferris and Mike DiBiase) help me avoid a lot of land mines and thrive in these challenging times." – Paid-up subscriber Scott M.

"I believe there's little reason for most businesses to raise their prices. It's just opportunistic of them because everyone's doing it. I went through McDonald's to get an Apple pie, which I hadn't bought for a while. The price used to be 99 cents plus tax (8.5%). I figured they had gone up but was shocked when the cashier said, "$2.15." Who came up with this laughable inflation rate of 8%? Seems more like 100% on most things!" – Paid-up subscriber Carla T.

"Hi, I agree we are in one heck of a pickle. Debt as far as the eye can see.

"However, I just wanted to let you know that contrary to the shipping information, that I have never seen so many semi-trucks on the road as my recent drive from Denver to Hampton Roads, Virginia. I have driven this route for 50 years, either on I-64 or I-70 through Baltimore, once or twice every year and was shocked at the number of semis on the road.

"By the way, the highways are a disgrace... How about updating the railroads for long haul and using semis for the last part of the trip? We are at a tipping point in so many ways... God bless America." – Paid-up subscriber Jim R.

"Corey, superb job... From my first economics class while I was in an MBA program in 1979, [recession is] two quarters of downward GDP. But as we found out recently, even that definition is malleable.

"Like many readers say, it all depends on where you are. Financially. And demographically.

"I, too, have been in full airplanes and crowded restaurants. But that doesn't mean we are or are not in a recession.

"I'm watching for company earnings, stock values, and dividend cuts. Many of Stansberry's prognosticators say a credit crunch is coming, and I believe it.

"I do think we are headed for tougher times in the economy – (shrinking GDP) and definitions be damned." – Stansberry Alliance member Jeffrey G.

"California, the new normal for gasoline is around $5 a gallon. Sales tax in So. Cal is 9.5%... on everything, even if its bought from somewhere else... The median home price in California is $725,000 – and closer to $1 [million] in Los Angeles County.

"I guess about the only thing not overpriced in California are the cherries I bought for $0.99 / lb. yesterday." – Paid-up subscriber Chris C.

Corey McLaughlin comment: I guess we should shop closer to the source for the cherries. But it would cost us a lot to get there.

"I grew up in Northern Michigan, near Traverse City – 'the Cherry Capital of the World.' The price for cherries DOES NOT reflect the price that the farmers get paid.

"If the farmers do everything right, and the weather is good, they have a 'bumper crop,' and the price that farmers get paid for cherries falls so low that they are left on the tree as it is not economically feasible to pay to have them picked and transported to the processors.

"When cherries are priced at dollars per pound, farmers are getting paid PENNIES per pound. I used to get paid 65 cents per lug (box) of cherries picked. I have seen prices paid to farmers as low as 12 or 16 cents per pound.

"That was decades ago, but the farmer does NOT get paid what he should." – Paid-up subscriber Keith H.

"I love all the input from other subscribers. A lot of cool points and unique perspectives from both sides of the 'Are we in a recession?' debate." – Paid-up subscriber Robert C.

Good investing,

Dan Ferris
Eagle Point, Oregon
June 2, 2023