Wall Street In Love

I rarely remember when the Street was as enamored as it is now. The object of its affection is a new technology called Artificial Intelligence, or AI for those "in the know."

Passions are riding high on the lower end of Manhattan as Analysts and Traders view the potential for this new "AI" as virtually limitless. Usually understated and reserved, the Street is captivated by projections of boundless wealth from this dynamic new technology.

Sparking this new "gold rush" was the introduction, in 2022, of an AI Application that anyone could use. ChatGPT created an all-new chatbot that promised to answer any question. For researchers, it is a wealth of news and data; for students, it is a source for that term paper; and for everyday users, it is a way to keep up with the latest news and information.

Launched by OpenAI in late 2022, ChatGPT was an immediate sensation, gaining 100 million users in just a few months. OpenAI is an engaging corporate structure comprising the not-for-profit research arm, OpenAI, Inc., and the for-profit OpenAI Global, LLC.

This allowed the not-for-profit to leverage various research entities to develop the chatbot while allowing Microsoft to gain revenue from its contribution to the project. Microsoft invested an estimated $13 million into OpenAI and provided its Super Computer to run the various applications.

After several attempts at developing a useful, user-friendly AI application, ChatGPT had struck gold. The sheer number of users was enough to alert Corporate America that something special was happening at ChatGPT. Nvidia was already on board, as it was the supplier of the AI Chips used in Microsoft Computer.

However, Tim Cook's phone must have been ringing off the hook in Cupertino, California, as customers were asking when Apple Computer would have a comparable product. Apple's response came with new versions of its iPhone, Mac Book, and iPad, which its newly created division developed: Apple Intelligence.

For both Google/Alphabet and Amazon, ChatGPT's success only contributed to their existing AI initiatives. Both companies had developed "virtual assistants " and cloud-based services that utilized AI, as well as other applications. For Tesla, Inc., a new set of AI-augmented robots is in the works. For Meta (Facebook), AI will provide augmented and artificial reality in various applications.

Although each of these companies provides different applications for their customers, AI united them all—that and the incredible Stock Market valuation that has followed. As we noted earlier, Wall Street is absolutely smitten with this new technology; they simply can't get enough.

When measured by the Standard and Poors 500 (the top publicly traded companies), investors have put 40% of their money into the top nine stocks, all of which are now AI-oriented. Those top nine stocks are Apple Computer, Nvidia, Microsoft, Google/Alphabet, Amazon, Meta, Tesla, Broadcom, and Taiwan Semiconductor.

It's a remarkable concentration of wealth. In dollar terms, of the $50 trillion in S&P 500 stocks, nearly $21 trillion is currently invested in these nine companies. Forget the other 490 companies that make up the rest of the Index; they'll have to fight over the remaining $29 Trillion.

Most interestingly, this concentration of wealth is almost entirely a bet on the future, not a recognition of current company performance. Investment Analysts have a way of measuring the relative value of a company's business. They measure the company's earnings (reported quarterly) versus its current price. This is, of course, the much-used Price-to-Earnings Ratio.

Consider the P/E Ratio as a simple benchmark, a way to determine the current stock price's cost versus historical norms. For instance, in the 21st Century, the stock market traded at a P/E of 20 X earnings. On average, you would expect to pay $20 for every $1 of a company's profits. Put another way, we expect a stock priced at $20 to have corporate earnings of $1. It's a benchmark; pay below $20 for that stock, and you're getting a bargain relative to the rest of the market. Pay above $20, and you're paying a premium over market value.

Currently, the majority of the stock market is trading slightly higher than normal, with a P/E of 26. It's a high P/E, but not excessively so.

So, how are our Top 10 Stocks trading? Would you believe that the P/E of the Top 9 is currently 52, double the rest of the market? Put another way, investors currently pay $52 for each $1 of corporate earnings for these AI-powered mega-stocks.

This is why the Top nine stocks trade for more than $1 Trillion, and Apple, Nvidia, and Microsoft, the three most AI-centric companies, trade for more than $3 trillion.

So, what does this tell us? Based on our standard P/E Benchmark, these stock prices are way out of line with historical valuations. While an average stock trades with a P/E of 26, these nine companies are priced at double that. This is because investors are totally enamored with their potential. Put another way, these elevated valuations are based solely on AI's future potential. Speculation on what might be, not on what is.

Market historians have a word for this particular type of investor behavior: a "bubble." It's when investors turn to speculators, and old benchmarks are thrown aside in believing that "this time is different."

Let's hope, for all of our sake, that this time truly is different because the alternative is most unpleasant.