AI Rocket Fuel - 1st Quarter 2024
The ACWI (All-Country World Index) rose over 8% in the first quarter to reach an all-time high. While interest rates remain elevated and inflation choppy, the U.S. economy appears to be marching on, exceeding expectations when it comes to both growth and employment. Though we continue to ponder how long this tightrope walk can last and how the Fed will navigate future interest rate decisions, financial markets, for the time being, have moved on to artificial intelligence (AI). Perhaps markets have shifted attention from one type of inflation to another—inflation of an AI bubble.
AI is a dynamic training model backed by enormous amounts of data and computing power. Its ability to ‘think’ and perform tasks should instinctively improve over time as it consumes more information and ‘learns’ from its mistakes. Human intervention acts as a guiding hand and determines how best to incorporate with current operations. AI in practical applications is a very new concept, and yet it is already adding value in healthcare, finance, supply chain management, power systems, cyber security, transportation, and beyond. Technological advancements, of course, do not benefit everyone equally. A recent report from the White House suggests 10% of U.S. jobs are highly vulnerable to displacement by AI-powered automation.
With the recent all-time highs, some investors are sounding the alarms, drawing comparisons to the Dotcom Bubble of the late ‘90s. The possibilities for AI to improve productivity and disrupt existing processes appear limitless. This is why many companies, particularly ones with scale and resources, are jumping in headfirst. Those that do not invest and adopt this new technology now, may be outcompeted in the not-too-distant future by those that do. This arms race is causing a frenetic pace of development and adoption.
To standardize our comparison, we are analyzing equity valuations as measured by the price-to-earnings ratio (P/E). From a fundamental analysis standpoint, the higher the P/E ratio, the more potential the stock has to be deemed overvalued, resulting in a price drop. Below compares the S&P 500’s P/E levels during the dotcom era and today.
Source: Bloomberg LP
As seen above, valuation metrics today are still 20-30% below the extreme levels seen during the Dotcom Bubble. The key difference being the macro environment surrounding these two time periods. Cash was more readily available, IPOs were running rampant, and many companies did not have the earnings to justify valuations. Today, this is just not the case with the IPO environment still thawing and stocks having to compete against the current yield of treasury bonds and money market funds for investor dollars.
Societal acceptance and deployment of AI will not occur in a smooth, linear fashion, and neither will the returns. There will likely be a market cycle in the sector, even if AI fully lives up to the hype. Legal battles continue to unfold regarding ownership of content and worker protections. We have far more questions than answers. And, yet, to us, this does feel more like a major turning point in human history than a short-lived fad. The AI renaissance may be just a matter of time…and timing is crucial in determining investor returns.
Thank you for reading and please reach out to continue the conversation.
EPIQ Happenings
EPIQ Investor Day – Save the Date! – Wednesday, May 22 (more details to come)
EPIQ Quarterly Reports – Updates to Benchmarking: Please note we have made two adjustments in the reporting benchmarks used to better represent broad-market index returns. For public market equities, we have consolidated the Russell 3000 and MSCI ACWI Ex U.S. indices into the MSCI All-Country World Index. This index better represents returns from a globe of investable stocks. The MSCI All-Country World Index is still heavily allocated toward the same companies that have driven equity returns over the last decade.
We have also included HFRX Global Hedge Fund Index as a broad-based measure for our ‘Alternatives’ category. While this is essentially a catch-all for investments that are not publicly traded stocks or bonds, it represents returns generated by non-traditional, illiquid investments such as real estate, infrastructure, private equity, and private credit. These are just a few examples of the type of investments that are better represented by this index, which is only priced once per month. This pricing cadence is due to the underlying illiquid assets’ lack of an active daily trading market.
These two changes have enabled EPIQ Reports to create the ‘Weighted Index Comparison’ line, reflecting what the blended index performance would have been, given the weighted asset allocation throughout a given period.
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