Research Affiliates’ founder Rob Arnott joins a chorus of voices debating whether stocks that have surged on the back of the potential of Artificial Intelligence are a risk or an opportunity. Arnott said the rise in large-cap technology stocks is looking a lot like the the dot-com bubble that burst in 2000. Investors will be better off in value stocks, Arnott argues.
In an interview with Institutional Investor, Arnott cautions investors about the high valuation on stocks of companies at the forefront in developing AI products, specifically the “Magnificent Seven” — Apple, Microsoft, Alphabet (Google’s parent company), Amazon, Nvidia, Tesla, and Meta. From January to June, the seven companies accounted for 70 to 75 percent of the return generated by the S&P 500, according to data from Richard Bernstein Advisors.
Arnott believes in the prospects for AI technology, but these companies’ stocks trade at prices that don’t justify the potential. Earnings may be slow to catch up with investors’ high expectations, he said.
“Is AI and the narrative surround AI a breakthrough, a bubble, or both? It’s both,” Arnott said.
There are plenty of investors on both sides of the AI debate. Richard Bernstein, who founded RBA, also argued that investors should diversify away from the large-cap tech stocks and look for growth opportuniites elsewhere due to the increasing concentration risks in the major indexes.
But investors in the opposing camp, such as Goldman Sachs Asset Management and Los Angeles Capital Management, believe that the rise of AI stocks is sustainable in the long term because their prices are justified by strong fundamentals. Cathie Wood, who invests in disruptive technologies through the ARK Innovation ETF, has also been deploying capital to AI leaders.
Arnott said, “2023 sounds exactly like 2000 to me. In 2000, we had a new paradigm…In this new paradigm, the leaders in the dot-com revolution had no earnings because they were investing in the future of the nation. [Investors believed] the earnings would come later and be stupendous.”
The narrative turned out to be true, but that didn’t benefit investors. “Why did they crash? Because it happened slower than expected,” Arnott said. Investors who put money into the Nasdaq index during the peak of the dot-com bubble needed 11 years to recover from the losses, according to data from RBA.
The short-term outlook for large-cap growth stocks will be furthered dampened by macro uncertainties, according to Arnott. He believes inflation will rebound later in the year. If that happens, investors will favor value stocks over the growth names.
“If inflation rebounding scares people, the impact on growth stocks will be pronounced,” Arnott said. “My expectation would be that value stocks will have an impressive comeback, at least in relative performance terms.”
