US stock indices have been on a tear in 2023, with the S&P 500 up 19%. However, virtually all these gains have been concentrated in a handful of stocks perceived to be the biggest beneficiaries of the euphoria surrounding AI. As valuations become ever more stretched, I see only one conclusion: a stock market crash.
A stock market defying logic
The latter stages of any bubble are almost always characterised by a narrow group of stocks surging. Cameron McCrimmon of Aegon Asset Management recently described this market as a classic “ageing bull”.
In early 2021 when the likes of Arkk innovation ETF peaked and began to roll over, the likes of Apple, Meta, Microsoft, Amazon and Alphabet kept on rising. Barely a year later and history is repeating itself.
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As the generals of the stock market continue to climb higher, the soldiers, the other 490 odd constituents of the S&P 500, are nowhere to be seen.
As fear of missing out (FOMO) grips the market, valuations have become totally detached from reality. For me valuations matter. Nvidia, for example, is trading at 40 times revenue on an expectation that it’s going to capture a significant portion of the estimated $1trn opportunity in AI chips.
Business cycles
The reason why I say valuations matter is because I believe in business cycles.
Nvidia could be right. It could very well end up being one of the dominant players in this industry. But even if it does, what it, (and nobody) knows, is how (and in what timescale) the AI revolution will play out.
History is littered with examples of companies that were at the forefront of a technological innovation and yet did not go on to become one of the dominant players. Or if they did, those who bought early into the stock on a promise of future success, had to wait a very long time to make any money.
In the early 1970s, Xerox was one of a group of 50 companies labelled the Nifty Fifty. These growth stocks were the must-buy stocks of their day.
Xerox, was an early pioneer of the ‘office of the future’ creating the photocopier and computer operating system. But never really capitalised on such innovations, surrendering leadership to the likes of Canon, Apple and Microsoft.
There is an alternative
The sharp rise in interest rates over the past year means that I don’t have to take the risk of buying such stocks. Today, short-term bonds (such as T-bills or UK gilts) have a coupon of over 5% and offer next to zero risk.
The growing disparity between a handful of stocks in the S&P 500 and the FTSE 100 index provides me with an unmissable opportunity to buy cheap shares, many of which offer high yields and strong potential for growth.
In particular, I’m very excited about commodities businesses. For example, while many investors have lost faith in big oil, I’ve been buying BP and Shell on the dip. I’ve also been actively buying shares in mining giant, Glencore which trades at a rock-bottom price-to-earnings ratio and is set for explosive growth in the future.
