Stocks related to artificial intelligence (AI) have been leading the market higher this year, with names such as Microsoft, Nvidia and Apple jumping between 33% and 218% year to date. These gains are reminiscent of the dotcom bubble in the late 1990s. I’m not entirely convinced we’re in a similar position, but we are certainly in a peculiar market.
Nvidia, the big daddy of AI, is trading at 232 times trailing earnings. That’s some multiple to “grow into”. But one stock does not make a bubble. As analysts at ETF firm WisdomTree point out, a composite tech index that includes stocks from different sub-sectors is trading at below 30 times forecast earnings today, compared with 55 times in the 1990s. That’s not cheap, but it is not a bubble.
Investment theory suggests that the more diversified you are, the better the risk levels and the more opportunity to capture what’s called market breadth. However, the AI buzz hasn’t been that broad or diversified – it’s really just about a handful of stocks. What’s more, I would argue that most investors who put money to work in AI-related stocks are not long-term investors. They are chasing momentum, which is a respectable strategy until it falls over.
If you believe – as I do – that AI will have a huge influence over many sectors, then frankly AI falls away into the corporate noise – the businesses that use it smartly will probably be the very biggest tech-enabled firms with access to deep wells of capital. They might not be clever AI start-ups or even the giants such as Nvidia or Microsoft (where you could argue that the disruption is already priced into the share price).
In simple terms, the momentum trade was, and maybe still is, just buying a handful of stocks in the short term. Later, one would bet on US mega caps because of their easy access to liquid capital markets to fund innovation.
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An alternative strategy is to try to pick stocks that will play the broadening out or diffusion trade – ie, the next generation behind Nvidia and Microsoft. That’s where the AI exchange-traded funds (ETFs) will undoubtedly come into play, such as the iShares Automation and Robotics ETF (LSE: RBOD), the Legal & General Artificial Intelligence ETF (LSE: AIAG), the WisdomTree Artificial Intelligence ETF (LSE: INTL) and the Global X Robotics and Artificial Intelligence ETF (LSE: BOTZ).
Another possibility is to try to out-think these ETFs and draw on the best ideas of active managers who are closely watching AI trends, such as the Polar Capital Artificial Intelligence Fund. For instance, Citywire has a tool called Fix the Future, which looks at the stock picks of the top active fund managers. You can screen managers based on sectors and themes, such as exposure to AI and automation. This screen gives you a handful of very familiar names, such as Alphabet and Tesla, as well as other large caps that use technology, such as Raytheon and Accenture. But it also throws up a whole bunch of less familiar names, many of which are in the aerospace and defence industry, such as Aptiv, Safran, Hexcel, AAR, and VSE.
If none of this excites you, I’d suggest one very left-field idea: back the venture capitalists who are investing in tomorrow’s ChatGPT. Most of the listed venture-capital plays in the UK, such as Molten Ventures (LSE: GROW), are pushing the focus of their portfolio towards AI and automation in some way.
A minnow fund called Forward Partners (LSE: FWD) is making a huge bet on AI, with many if not most of its portfolio companies “classified as AI, being businesses that are either applying AI or have generative AI products in market or near launch”. With its share price down at 24p, the market is currently applying an 80% haircut to the value of a portfolio. It’s risky, but that haircut leaves a wide margin of safety for investors.