Is the artificial intelligence boom on Wall Street a bubble primed to burst or the real deal? That's the question investors have wrestled with since the Magnificent Seven tech stocks began turbocharging a powerful market rally last year.
Jeremy Grantham, the investor famous for predicting the dot-com crash in 2000 and the financial crisis in 2008, has an answer Wall Street won't like: He believes that AI is a bubble that could start letting out some air.
"A new bubble within a bubble like this, even one limited to a handful of stocks, is totally unprecedented," he wrote in a Monday blog post. "The best guess is still that this second investment bubble — in AI — will at least temporarily deflate."
Tech stocks surged to eye-popping heights in 2023, and that story has continued this year. Monster gains in shares of tech giants, particularly US chipmaker Nvidia, have propelled all three major indexes to all-time highs. The S&P 500 index on Tuesday logged its 17th record high close of 2024.
Grantham, who is co-founder of Boston-based GMO LLC, isn't buying it. "The long-run prospects for the broad US stock market here look as poor as almost any other time in history," he wrote.
One reason he cites for his skepticism is that history suggests the market is overdue for a sharp pullback.
Stocks were pummeled in 2022, with the S&P 500 logging a double-digit percentage loss after the Federal Reserve began raising rates aggressively to bring down inflation. But the stock market had seen strong returns in the year leading up to those losses, as near-zero interest rates gave firms easy access to cash, a bevy of companies went public and investors took on more risk in their portfolios.
Grantham says that the exuberance showed all the classic signs of a bubble about to burst. While that began to happen during 2022's painful sell-off, it was interrupted by the launch of ChatGPT in November 2022 that jumpstarted today's tech-heavy rally, he says.
But Grantham believes that was a pause, not a stop, and that the sell-off will eventually continue. Not only that, he sees an economic downturn on the horizon.
It "seems likely that the after-effects of interest rate rises and the ridiculous speculation of 2020 to 2021 and now (November 2023 through today) will eventually end in a recession," he wrote on Tuesday.
Still, the notorious market bear sees some areas of opportunity in the stock market. He recommends that investors take a look at quality stocks, which he defines as shares of companies with a high, dependable return on equity and a strong balance sheet. Grantham also noted that he likes shares of companies involved in areas like energy and metals.
"Raw materials [are] finite — believe it or not! — getting scarcer, and therefore certain to rise in price," he wrote. "They are far and away the most diversifying sector."
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