Are We in an AI Bubble? What You Should Know Right Now

In this episode of Friends Talk Financial Planning, Bridget Sullivan Mermel and Luke Van de Loo talk about a question everyone’s asking but few truly understand. With AI stocks going up and new companies launching every day, it’s getting difficult to separate true value from too much promise.

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TRANSCRIPT:

Bridget: Today Luke and I are going to talk through the AI bubble and what you should be concerned about. So Luke, first, what is a bubble? How do we know that there's a bubble? Or is there a bubble? What are your thoughts?

Luke: You know, it's a great question. We've been seeing it all over the news lately and getting lots of questions from clients, friends, family. It seems like stocks have gone up for the past few years and all the AI stocks, the big tech stocks, are driving all the market performance.

Bridget: Right.

Luke: And so, it can start to feel like this could be a repeat of something like 2000, right?

Bridget: Yeah, I think 2000 particularly sticks with people because it was also tech oriented. And I think there's some things that are similar and then some things that are different. The similar thing about around 2000 is that there's a lot of investment in tech and that that really was driving market growth.

The thing that's different is that so many of the companies now that are pouring money into it are well-known big players that are already profitable, and they haven't known what to do with their money, it seems like in the last decade. So now they're investing in this. And so those things are the kind of two balancing factors. Well, how is it similar and how is it different? What are your thoughts?

Luke: Well, on the encouraging side, as you mentioned, there are reports that many of these companies, like Amazon, Meta, Google, could just sort of turn off their AI capital expenditure spending, meaning investing in data centers, investing in all their AI models and all that. If they just turn that off, they would be wildly profitable and people say, “Oh yeah, that would totally justify their current valuations.”

Now of course, if that happened, there are some of the other stocks that have gone up a lot, Nvidia for example, that would have a really hard time, because their entire business model is having other people do AI capital expenditure. But that's reasonably encouraging. Oh, these big companies, super profitable, very diversified. Microsoft is basically an ETF in and of itself these days given how diversified it is.

And many of those business units are profitable and so turn off the capex and justify the valuation. That doesn't sound too much like a bubble. Right. However, you do hear other things that get a little bit concerning. For example, I was talking to one of my friends who said, “Oh yeah, you know, there was that SoftBank investment firm, the very large Japanese investment firm, and they just sold all their stake in Nvidia. Don't they think that the reckoning is coming?”

And I said, “Look, they sold all their stake in Nvidia, and they bought a big stake in OpenAI.” And on the one hand it's like, oh, the institutional investors might see a whole bunch more room for growth here. That could be encouraging from one perspective. On the other hand, if all the investment gains are just being reinvested in a different flavor of the same thing, that sounds like it might be sort of frothy behavior.

Bridget: Right. Frothy. That's the latest. So it's like investing the money into the same kinds of things means it’s kind of getting heated up. The one thing I would say that's positive when we look at other bubbles, particularly 2008, that does seem to be different here, and I'm curious about your take on this, is that it's not like a lot of the growth is really a direct result of leverage or borrowing to then go and invest.

It seems to me that it's more like these companies are making a lot of money, and they're taking the money that they're making and investing. Not saying that there's no leverage, I'm just saying that's not what's fueling all the bubbles. I don't know. That might not be the bubble machine, let's put it that way.

Luke: Well, leverage definitely increases risk. I think that's a well-accepted fact. You may have seen in the news lately that leverage is starting to increase. I think Meta just turned on a whole bunch of corporate debt to fund more data center expansion. So there could be some of that starting to come into play. And so, I'm curious from your perspective, Bridget, bubble or not, we can't be sure either way, but what should we do about it or how should we think about taking any action, if any?

Bridget: Well, I think that maybe the valuations of the prices are too high right now, and they'll be in an adjustment. But I think AI is here to stay. The other thing is that I think people don't understand the history of AI, that it has actually been around for a long time, and now it's like ChatGPT caught fire with people like me. It's just got a lot more adoption than AI has gotten before. So it's kind of like there was a lot of potential there, and then all of a sudden it kind of caught fire and now it might be a little bit overhyped now, but that's not to say it's going to go away or that these investments aren't going to pay off.

There just might be more volatility right now. So what do you do with volatility? You hang on for the ride, and you just do the regular boring stuff. Make sure you're well-diversified so you're not all in tech stocks, first. That's part of your portfolio, but just whatever the market is. And then, remember that the more companies you have, the better off you are. Make sure you're not taking more than you should.

If this is really bugging you, that's a sign that you should maybe take a little bit less risk. It’s much better to feel uncomfortable when the market's high. I want to sell the market's high. That's a much better indicator than when the market's low and you want to sell. If you only realize you've got too much risk at the bottom, that's a drag because then you're regularly selling low. So you might want to make some adjustments if this is making you really uncomfortable, but to your overall strategy, not just to tech stocks.

Luke: Yeah, I mean, I think that is a very reasonable approach overall. What are some of the ways that we hedge against if this is an AI bubble?  What if this is going to be a repeat of 2000 where the US stock market is flat for the next 13 years? 0% average return for 13 years. And you know, it's not exactly how it works.

There are ups and downs in the meantime, and you can rebalance and hedge the risk a little bit that way. But what if that's what the US stock return is for a while? Well, that's why you own bonds, right? That's why you own lots of international stocks. That way, even if we end up with another really poor period of performance like that, you'll still have these other diversified assets that are still going to be at least having the opportunity to grow if the US Stock market ends up having a really difficult period.

Bridget: Yep, it seems like that's a great time to wrap it up. Hi, I'm Bridget Sullivan Mermel. I've got a fee-only financial planning practice in Chicago, Illinois. And this is my special guest, Luke Van de Loo.

Luke: Great talking to you today, Bridget.

Bridget: Yep. And he's in Chicago, too, actually with my firm. So if you want to speak with us, you can check out sullivanmermel.com or check us out in the how notes. We're also members of the Alliance of Comprehensive Planners. And you can check out other planners that might be in your area if you're not interested in virtual meetings at acplanners.org. And please subscribe.

At Sullivan Mermel, Inc., we are fee-only financial planners located in Chicago, Illinois serving clients in Chicago and throughout the nation.  We meet both in-person in our Chicago office and virtually through video conferencing and secure file transfer.