By As tech earnings season approaches, industry experts are buzzing about the future of artificial intelligence (AI) and its potential to drive substantial profits for companies and investors in the coming years and decades. This discussion has even spurred the emergence of nicknames like the “Magnificent Seven” to describe the mega-cap tech giants leading the AI revolution. These giants include Nvidia Corp., Apple Inc., Microsoft Corp., Tesla Inc., Facebook parent Meta Platforms Inc., and Google parent Alphabet Inc.
However, amid the excitement, it is important for investors to remain grounded and not fall victim to what is known as the “big market delusion.” In a recent interview, Rob Arnott, founder of quant-focused Research Affiliates, warned investors of this mindset. Coined by professors Brad Cornell and Aswath Damadoran, the term describes a scenario where an oversize market forms around a new innovation. Their research has shown that overconfidence among entrepreneurs and their financiers often leads to overpricing of companies in these alleged big markets.
Arnott and Cornell further explored this phenomenon in relation to electric vehicles (EVs) in a subsequent paper. They discovered that the delusion assumes that the dominant players in the early stages of a new market will always be the dominant players and that transformative change will occur rapidly. However, history has shown that this is not always the case.
Looking back at the tech bubble of the early 2000s, Arnott recalled how Qualcomm Inc. experienced a meteoric rise in its stock price. This was fueled by a narrative that Qualcomm was indispensable in providing the infrastructure for the internet, possessing an insurmountable competitive advantage. Investors bought into this story without considering the valuation, assuming that Qualcomm’s dominance was guaranteed.
Ultimately, the market bubble burst, and many investors suffered losses. Arnott’s cautionary tale serves as a reminder to approach new technologies and markets with a balanced perspective, rather than succumbing to the allure of exaggerated promises.
In conclusion, while AI undoubtedly holds immense potential, investors should exercise caution and avoid getting caught up in the hype. Diligent research, realistic expectations, and a long-term view are essential for navigating the evolving landscape of technology and achieving sustainable investment success.
The Long-Term Gains of Qualcomm
Did you know that Qualcomm’s profits have grown an astonishing 60-fold in the past 24 years? It’s an impressive feat. However, if you had invested $100 into Qualcomm in 2000, it would have taken a long 18 years to see a positive return on your investment.
According to FactSet, Qualcomm delivered a cumulative return of around 224% from 2000 to 2023. While this is indeed substantial, it falls short when compared to the S&P 500’s return of 411% during the same period.
The AI Narrative: Transformative but not Immediate
The AI narrative is now being compared to Qualcomm’s story. It is partly correct to say that AI will be transformative, similar to how the internet changed our lives. However, what’s incorrect is the belief that AI will bring immediate change and that today’s dominant players will still reign supreme in the next five or ten years.
To illustrate this point, consider the case of the Palm Pilot. In 2000, it was spun off as Palm Inc. from 3com and briefly saw its market capitalization surpass that of General Motors. Yet, BlackBerry soon emerged as a challenger, taking over Palm Pilot’s market share. But even BlackBerry was eventually upstaged by the Apple iPhone.
The lesson learned here is that even big disrupters can be disrupted over time.
Overcoming Delusions: Investing in Industries Poised for Productivity Boost
So, if we acknowledge that AI will indeed transform the economy, how can investors avoid being deluded by the current industry leaders? According to Arnott, the key is to recognize that the majority of benefits from technological revolutions are enjoyed by customers and users rather than the innovators themselves.
Therefore, a smart approach would be to analyze industries likely to experience significant productivity boosts from AI. Additionally, consider whether consolidation within those industries will enable them to achieve higher profit margins.
In this way, investors can align themselves with the AI boom in a more strategic and insightful manner, rather than relying solely on the current industry leaders.
Beware the Hype: The Fate of the Magnificent Seven
Nowadays, there is much hype surrounding the so-called “Magnificent Seven” companies believed to be on the verge of reaping enormous windfalls from AI. If you find yourself caught up in this enthusiasm, perhaps it’s worth revisiting the iconic 1960 Western film from which this group gets its name.
As Arnott points out, by the end of the movie, four out of the seven characters meet their demise. It serves as a reminder that even the most prominent players can face unexpected challenges and fall from grace.
In conclusion, while Qualcomm’s long-term growth is commendable, it took considerable patience to reap the rewards. Similarly, the AI revolution may indeed bring about significant changes, but investors should approach it with caution and focus on industries poised for productivity gains rather than simply following the current leaders.
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