Have no doubt about it: AI stocks are in a bubble

Almost everyone may want to own AI stocks at the moment, but this Fool sees echoes of the dotcom bubble and believes they may crash.

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Artificial Intelligence (AI) stocks and mega-cap tech have been the standout performers of 2023. Investors have been piling into a handful of stocks, excited by the next big growth narrative.

As the valuations of the likes of Nvidia and Tesla look increasingly like they’re becoming detached from reality, echoes of the dotcom bubble are, just like in 2021, emerging again.

Now I can hear the cry from the bulls: “This time it’s different!”. No, I don’t believe it is. As the old saying goes, the bigger they are, the harder they fall.

Mega-caps vs the rest

Although US indices have outperformed the likes of the FTSE 100 in 2023, delving deeper highlights this rally is being driven by just a handful of stocks.

The following chart shows the breakdown in performance year to date for some of the most popular stocks. Nvidia is leading the way, having tripled in price. The Nasdaq Composite, which houses all of the mega-cap names, is up 33%. But the S&P 500 is only up 16%.

Source: Trading View

When one goes even deeper and analyses the much broader Russell 2000 index, which houses small-cap names, performance year to date has been flat.

The divergence between the smaller-caps and the Nasdaq 100 is growing ever large. Indeed, what is interesting is that the ratio between the two now sits at the same level as at the peak of the tech bubble in early 2000.

History doesn’t repeat itself, but it rhymes

I have no doubt that AI is going to fulfil on all its promise and be as revolutionary as the internet and online retailing was heralded to be 25 years ago. But does that make the likes of Nvidia a buy today? I don’t believe so.

In 1999, Amazon predicted an internet shopping revolution that would herald in a new era. If I had bought the stock at its peak back then, and held it for 24 years, I would now be very rich. But that would be a very big ‘if’.

By the end of 2001, the stock had lost 95% of its value. I would have to have held the stock for another 10 years just to break even. And don’t forget, Amazon was one of the few winners to emerge from the tech bust.

Identifying AI winners

Much like Amazon a quarter of a century ago, identifying the AI companies that are going to be truly transformative is akin to looking for a needle in a haystack.

Back in the 90s, the likes of Intel, Cisco, Oracle and AT&T helped build the internet. But it was start-ups like Google and Facebook, with innovative business models, that were the ultimate winners.

I’m confident that most of the leaders of the last business cycle will not be the leaders in the next. That’s simply not how it works. The leaders of tomorrow will be those companies that apply AI technologies in new and disruptive ways.

I acknowledge that this rally in tech stocks could go on a lot longer. But that will only magnify the risks even more. For now, I am looking elsewhere to invest my hard-earned money.

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

Randi Zuckerberg, a former director of market development and spokeswoman for Facebook and sister to Meta Platforms CEO Mark Zuckerberg, is a member of The Motley Fool's board of directors. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Andrew Mackie has no position in any of the shares mentioned. The Motley Fool UK has recommended Alphabet, Amazon.com, Meta Platforms, and Nvidia. Views expressed on the companies mentioned in this article are those of the writer and therefore may differ from the official recommendations we make in our subscription services such as Share Advisor, Hidden Winners and Pro. Here at The Motley Fool we believe that considering a diverse range of insights makes us better investors.

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