Ataraxia Financial Newsletter - June 2023
AI Expectations Drive Tech Stock Valuations to New Heights
“In the short run, the market is a voting machine but in the long run, it is a weighing machine.”
—Benjamin Graham
and…
The market is like a large movie theater with a small door.
And the best way to detect a sucker is to see if his focus is on the size of the theater rather than that of the door.
— Nassim Nicholas Taleb
Friday, July 1st. Busan, Korea.
One cool thing about Korea that I have always enjoyed is the ease and convenience of finding and getting to nice hiking spots.
Pretty much all of the country is covered by mountains and hills and there are only smaller areas in the valleys that are expedient for being used for agriculture, mostly rice fields.
The mountains are not very high, but there are mountains everywhere and they are mostly quite easy and convenient to access. And since Koreans love hiking, the trails tend to be clearly marked and are well maintained. So, whether I was in Seoul, Busan, Jeonju, Daegu or Sockcho, it was always easy to find a good hiking opportunity that can conveniently be accomplished and requires less than a half day.
Speaking about Koreans and hiking… Koreans are probably the most professional when it comes to several things — and hiking is one of them.
Even though the routes are well maintained, not at all difficult (at least not technically), and often provide stairs and other kinds of constructed support, most Koreans engage in the endeavor as if they were attempting to climb Mount Everest.
From the newest hiking shoes to the most fashionable functional clothes (with multiple layers and always covering the whole body to protect from the sun — and vitamin D 😆) and backpacks. Sometimes even with ropes and always with hiking poles.
In contrast, I probably must look quite eccentric to them, with just a small city backpack and my running shoes (once I even went with my flip flops 😅)… and when it’s sunny and I’m sweating, I also tend to pull off my T-shirt and get additional sunlight exposure.
In any event, while I am here, I have mostly swapped my weekly steady-state cardio gym session, or long run, for a nice afternoon hike as my fundamental endurance workout.
In addition, I am a big Iced Americano lover, and while Korea has also seen significant price increases over the last few years and is definitely not a very cheap place, Iced Americanos are available everywhere and are super cheap!
Thus, I have come to make it a habit to briefly check for an interesting hiking trail, take the bus or subway, put on an interesting podcast, grab an Iced Americano and go for the hike. And I tremendously enjoy it!!!
This month's newsletter is going to be brief. I just want to share some thoughts on the recent stock market rally, which is mainly driven by the enthusiasm of what the AI might enable in the coming years.
Let’s first have a glance of what has been going on in the markets last month.
Here are the Key Indicators for the month of June:
For the first time since the hiking cycle stated, the Federal Reserve has paused hiking rates in the last FOMC meeting. The market seems to be highly confident that this might mark the end of the hiking cycle and that we will not see any further rate hikes. In addition, it appears like the hiking policy has been successful and has done most of its jobs with the continuation of lower inflation numbers.
This confidence combined with the speculation about what efficiency increases can be materialized through the implementation of artificial intelligence, the stock market — especially the technology sector — has seen a spectacular rally.
Here are a few bullet points to give a glimpse of what I am talking about:
The Nasdaq had its best first half year in over 40 years.
Apple is the first company to reach a valuation of $3 trillion. It is up 55% YTD.
Nvidia is up almost 200% so far in 2023. 🚀
Moreover, the VIX, which is also known as the fear index and is often used as an indicator for fear, risk and uncertainty in the market, has come down to a very low level, one that we last saw before the war in the Ukraine started:
The AI Speculation Rally
"Artificial intelligence, the spark of innovation that dances between lines of code, holds both the promise of extraordinary progress and the weight of profound responsibility. As we unlock the mysteries of AI, let us tread with wisdom, for in shaping its potential, we shape our own destiny."
— ChatGBT
Since ChatGPT has been released, it has been the major topic over the last months and there are huge speculations about all the future implications that the use of artificial intelligence will bring to us.
I was actually also quite baffled from the first moment I tried out ChatGBT myself. I remember that it was an evening in January when I was in San Salvador and I ended up, having a “chat conversation” with ChatGBT all night long. It was a mind-blowing experience and I was just fascinated by its capabilities, so I couldn’t stop asking questions.
Since then, I use it almost on a daily basis. It has basically replaced the function of Google searches for me and is also very helpful and saves lots of time for any work that I do. (Even while writing this newsletter I have an open ChatGBT tab, in case I have any questions or looking for some word or synonym that doesn’t come to my mind. For example, I asked to give me a quote about AI and its implications for humanity, which resulted in the above quote).
In my mind, there is no question that the implication of the abilities AI technologies, such as ChatGBT offer, will significantly enhance productivity of companies.
The question is, how much should it affect the current stock market valuations? And which companies benefit the most from it?
According to what we see in the markets, the big winners are the technology companies, especially those that engage in the production of semiconductors and develop software.
The poster-child of this recent rally has been Nvidea.
Nvidea is mainly engaged in producing GPUs and 3D visualization in video editing and the gaming industry, but over recent years also has made significant advancements in AI and deep learning. In other words, it’s the company that builds the stuff that AI relies on.
And now it is also the 6th. company that has passed the $1 trillion mark.
The others are:
Apple → $3.46 trillion
Microsoft → $2.53 trillion
Saudi Aramco → $2.07 trillion
Alphabet (Google) → $1.53 trillion
Amazon → $1.34 trillion
One metric that is commonly used among investors to gauge whether a company is overvalued is the Price-to-Earnings Ratio, or just P/E ratio. It is calculated by dividing the market price per share of a company by its earnings per share (EPS). The P/E ratio therefore provides an idea of how high the price is in comparison to its profitability.
The average P/E ratio across the S&P500 is currently at 22.23. Historically. it tends to be somewhere between 10 and 20.
To put it into perspective, the current P/E of Nvidea sits at 219.85. This means that if you would buy a share of Nvidea you would need to wait 220 years until the Nvidea could pay all the dividends at their current earnings.
Hence, the valuation only makes sense with the expectation that Nvidea will be able to massively increase its earnings in the future.
Is that possible? Well, everything is possible.
Is it likely? I am not so sure.
There is one chart that I saw in an article I was reading quite a while ago and that stuck with me:
This chart always pops into my mind when I think about AI. (The full article can be read here: Part 1 & Part 2. I highly recommend it, but as a warning, it is a long read).
Recently I happened to watch a German report in which they were talking about students, using the technology to “cheat” on their homework and projects. The “expert” who was interviewed at the end of the report confidently stated how even though AI has made some progress, it is not yet capable to show the same amount of capabilities in naturally expressing emotional feelings in its writing as “real” humans can do — I was just thinking about the chart and how AI had probably just shot past her on the intelligence scale at the very moment she had finished the phrase. 🤣
In any event, even if AI massively increases overall efficiency, which I think is very likely, it is still not a given that the companies engaged in the current development and chip production, will be able to reap all of those benefits.
I personally would not invest in Nvidea at its current valuation.
If I were asked to describe the investment landscape and boil it down to a few bullet points, I would do it like this:
The most important price in the market is the interest rate. Artificially low interest rates over many years have led to:
large malinvestments across the globe.
Manipulation of all prices.
Way too high debt levels, both public and private.
Many political promises of public spending in order to get votes, all financed by debt, which is not sustainable.
Super high time preference!
A society that has abandoned the principles of honesty and self-responsibility and has replaced them with a sense of self righteousness that looks at the state as manager and rescuer for every problem.
In the long-term this cannot be sustained, and the two possible outcomes are:
A collapse: Massive bankruptcies, unemployment and a stock market crash.
Money printing on steroids → leading to massive inflation.
In other words: Inflate or Die.
→ Last year and earlier this year we saw the house of cards tremble a bit, but the day of reckoning with all of its necessary consequences is still ahead. 🫣
Thus, coming back to our issue at hand, I think Nvidea — just as most of the stock market — is largely overvalued.
Remember the quotes with which I started this newsletter? (If not, scroll back up 😉)
Right now investors have high confidence in the market. They believe that the FED is done with hiking rates and that efficiencies gained through the implementation of AI technologies justify the highly elevated prices of stocks in the technology sector. Hence, the voting machine makes the prices rise to these astronomical valuations.
However, don’t be a sucker.
💡One final thought: In a (maybe not so distant) future scenario, in which AIs can by themselves control financial resources, trade and initiate transactions, I am sure that they are not going to touch Dollars, Euros or Yen. They are definitely going to be smart enough to evade these manipulated fiat currencies which are destined to loose value over time. Instead, I think it is far more likely that they will use some form of frictionless cryptocurrency and probably choose the hardest existing form of money — Bitcoin — as the basic underlying settlement layer.
We will follow the development, try to connect the dots on the way and report about it, wherever it might go.
Stay tuned!
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Best regards,
Disclaimer: The content of this newsletter is for informational and educational purposes only. It contains my personal views and opinions, which are not to be taken as direct investment advise. All investments have risks and you should do your own due diligence before making any investment decision. If you require individualized advice, to review your unique situation and make a tailored advice for you, then contact a certified financial planner or other dedicated professionals.