Myles Zyblock, Chief Investment Strategist of Scotia Global Asset Management – which manages over $200 billion* for millions of investors in Canada and around the world – shares his latest market and investing insights.
This month, Zyblock analyzes the rise of artificial intelligence-related stocks and looks to lessons from the dot-com boom for how things may play out.
The beginning of the 1990s dot-com boom can probably be traced back to the Netscape Communications Inc. IPO in 1995. The company, which made the first widely adopted Internet browsing software, saw its stock price double on the first day of public trading. This was like a gunshot that signalled a dramatic change in the marketplace or, as Hyman Minsky (an American economist best known for studying the characteristics of market movements) might have said, it was an initial “displacement,” which takes the form of a disruptive technology and gets everyone excited.
The launch of ChatGPT, an artificial intelligence (AI) chatbot developed by OpenAI based on the Generative Pre-trained Transformer (GPT) technology, in November of 2022 could represent a similar type of displacement to what Netscape unleashed in the mid-1990s. Many analysts believe that generative AI (systems capable of generating text, images, or other media in response to prompts) will be among the most impactful innovations over coming decades, driving productivity growth across the global economy. While OpenAI is a private company, its effects have been felt across the public equity market. Pure-play AI companies, those investing in or developing generative AI applications, and semiconductor providers focused on high-performance AI chips have been caught in the buzz.
Enthusiasm surrounding the last major technology boom lasted until early 2000, an almost five-year span, which pushed equity valuations to previously unseen heights. If ChatGPT signals the beginning of a similar era in innovation, the valuation expansion for the associated stocks is probably only just getting started. The size of the global AI market is hard to gauge, with wide-ranging estimates. But one thing is clear: the large expected annualized growth rates for this market are certain to maintain a wide base of investor interest.
The AI “Buzz”
The technology-heavy NASDAQ Index has appreciated by nearly 40% in the period immediately following OpenAI's late-2022 launch and free preview of ChatGPT. NASDAQ’s performance seems like more than a simple coincidence.
News stories that spoke about exciting AI opportunities flourished in the business and financial press immediately after the ChatGPT launch. Companies, especially in industries most immediately and directly affected by AI, began to talk about the technology's benefits to their business in their earnings calls. The exciting news about this technological tool is travelling fast.
The influence of AI on market dynamics
The S&P 500 has appreciated by about 15% so far this year, confounding many analysts who have been concerned about the general health of the global economy and corporate earnings. The lion's share of this year's index gains is attributable to the ~50% rally in a small group of stocks most directly associated with the AI technology. The returns generated by the remaining 96% of companies in the index have been a much smaller 3.5-4.0% on a year-to-date basis.
Recent market dynamics seem consistent with an investor base both concerned about the macroeconomy and grappling with the exciting potential of AI.
Valuation considerations
After the big price rally, the AI-themed basket of S&P 500 stocks is currently trading at 29 times the 12-month forward earnings estimates. This represents a 50% valuation premium relative to the index and 71% premium versus the non-AI stock universe.
The higher P/E ratios carried by AI-leveraged companies are probably a small upfront price to pay if industry analysts are even in the ballpark on the annualized growth rates being north of 20% for this market over the next five to seven years.
It is difficult at this stage to determine how widespread or how useful this technology will be in business applications. The uncertainty is clearly reflected by the wide range of estimates we have seen from both the Wall Street analyst community and other industry consultants on the size and growth of the total addressable AI market. Nevertheless, the overwhelming view is that this is likely to represent a rapidly growing and important business opportunity for companies over the next several years.
An investment bubble?
Some investors are beginning to question whether the recent price action for some companies reflects a valuation bubble. To get at this question, we looked at the distribution of U.S. stock valuations, using the price-to-sales ratio, for three different periods: (1) The end of 1995, or soon after the Netscape IPO, which many people believe marked the beginning of the 1990s tech boom; (2) late-1999 which, with the benefit of hindsight, defined the ending stage of that tech boom; and, (3) the present time. Today's extreme valuation readings have surpassed that seen in 1995 but don't hold a candle to what we saw by the end of 1999, right before the bust.
Myles Zyblock is a recognized North American strategist, regarded for his investment insights that blend finance and psychology to capture major inflection points in financial markets. Myles has over 25 years of experience in guiding and advising on asset allocation for a diverse set of institutional and retail advisors globally. Myles joined the firm in 2013 as the Chief Investment Strategist, working closely with the Investment Team. His experience spans multiple asset classes and geographic regions.
*Total assets managed by 1832 Asset Management registered investment professionals. Scotia Global Asset Management includes 1832 Asset Management L.P., a limited partnership, the general partner of which is wholly owned by Scotiabank.
Commissions, trailing commissions, management fees and expenses all may be associated with mutual fund investments. Please read the prospectus before investing. Mutual funds are not guaranteed, their values change frequently and past performance may not be repeated.
Views expressed regarding a particular company, security, industry or market sector are the views of the writer and should not be considered an indication of trading intent of any investment funds managed by 1832 Asset Management L.P. These views should not be considered investment advice nor should they be considered a recommendation to buy or sell. These views are subject to change at any time based upon markets and other conditions, and we disclaim any responsibility to update such views. © Copyright 2022 1832 Asset Management L.P. All rights reserved.
