Managers comment on whether AI is driving a stock market bubble

Bubble – what bubble?

Craig Baker, Chair of the Alliance Witan investment committee, said: “We’ve heard quite a few loud warnings of a bubble recently, but I think the jury is still out. You need to differentiate between AI-exposed companies with strong fundamentals, like some of the Magnificent Seven which are highly profitable, and the raft of nascent businesses benefitting from investor enthusiasm for the AI theme.

“There may well be a bubble in the share prices of the latter, some of which don’t even have revenues let alone profits. And the valuations of some of the former are also starting to look a bit stretched. But even if there’s enough evidence to worry about being in a bubble, there’s not enough to suggest it’s about to burst.”

Mike Seidenberg, Manager of Allianz Technology Trust, said: “From our perspective here in San Francisco, we don’t see an AI bubble and the investments we are seeing from the likes of Microsoft, Google and Meta suggest that the demand for AI services should continue to increase.

“The services being deployed are creating real cost savings and we are still in the early days. Most of these companies are building these services for contracted revenue and not future capacity. Having said this, we do expect stocks to ‘zig and zag’ as they have done with previous secular themes in technology. Thus, having a long-term perspective is more important than ever, and the trust is positioned for the next 12 to 18 months, not the next quarter.”

Paul Niven, Manager of F&C Investment Trust, said: “On balance, while valuations are high and we are not complacent about the risks, I do not believe that we have an AI bubble at present. Of course, some stocks will fail to live up to current expectations, but we believe that the general outlook for equities remains positive.”

Alex Crooke, Co-Manager of Bankers Investment Trust, said: “Almost by definition it is hard to have a bubble when so many market participants are worried about a bubble. Back in the final year of the dotcom boom there were 70 large stocks that appreciated more than 1,000% and over 350 IPOs. We have not seen that degree of excess in current markets.”

Why is it different this time?

Ben Rogoff, Lead Fund Manager of Polar Capital Technology Trust, said: “The dotcom infrastructure build is probably the best (and most recent) parallel for today’s cycle. A profound new technology that’s likely to change the world cannot be supported with existing infrastructure. Then, circuit-switched networks; today, CPU-based computing power.

“E-commerce now represents around 30% of UK retail sales, and more than 70% of global advertising spend. Entirely new industries such as smartphones, the app economy, cloud computing, and software-as-a-service were made possible by the internet. We expect AI to have an even greater impact, as it potentially addresses all knowledge work, roughly half of developed world GDP.

“Naturally, there will be similarities with the internet buildout, but we’ve long believed that history doesn’t repeat, it rhymes. The AI revolution is likely to unfold far faster than the internet because it builds upon earlier advances: the smartphone, the cloud, and the prior digitisation of knowledge. For context, it took Google 11 years to reach one billion daily searches, whereas OpenAI achieved that milestone in just over a year.”

Paul Niven, Manager of F&C Investment Trust, said: “The dotcom boom was based upon the premise that the internet would transform business, which subsequently proved to be correct. Due to excess speculation, stock prices detached from fundamentals and overinvestment led to poor returns for many investors (and companies).

“There are similarities in terms of the excitement about the technology’s widespread and profound impacts on many parts of the economy. Nonetheless, compared to the late 1990s, the adoption rates for Generative AI have been quicker than during the dotcom boom and will, arguably, have a bigger overall economic impact in numerous ways.”

Richard Clode, Co-Fund Manager of Bankers Investment Trust, said: “There are significant differences to 2000 that help us gain comfort in today’s market and our ongoing significant exposure to the technology sector. Notably, valuations today for the majority of AI leaders are dramatically lower than the dotcom era thanks to accelerating profit growth and seasoned, experienced management teams navigating this new technology wave in a rational manner.

“In addition, many commentators ignore the impact of the Y2K effect and the related pull forward of demand in 2000, which led to a spike in technology purchases as retailers and other businesses upgraded systems to avoid potential disruptions from the change. This created a temporary surge in demand, borrowing growth from future years.

“New technology waves build on prior ones and consequently we expect AI to be delivered faster than the internet, which had to wait for fibre broadband and 3G, 4G and 5G networks to be built out along with the launch of the iPhone in 2007 and the App Store in 2008. In contrast AI will be delivered through existing cloud infrastructure, smartphones and connecting networks even if significant investment will still need to be put in to train AI models as well as to support growing AI inferencing demand as we use this technology more.”

What lessons do you take from the dotcom boom that are useful today?

Paul Niven, Manager of F&C Investment Trust, said: “There were numerous warning signs which preceded the bust of dotcom stocks, including; severely extended valuations, tightening monetary policy, several material setbacks in the Nasdaq and extreme price momentum in the year prior to the peak, declining national profits, widening credit spreads, clear signs of over-investment and excessive debt-financed spending leading to high leverage in many companies. Added to this there was a collapse in market breadth and increasingly speculative ventures receiving financing.

“All of these points, and more, are worth considering when one considers the landscape today. In summary, the premium of the mega-cap tech stocks is around the average levels to the market (based on data since 2017/2018), earnings momentum is still positive, capex plans are rising but not yet at extreme levels (and largely financed from cash) and there are only pockets of speculation thus far. We are not complacent and are maintaining a checklist to assess how, and when, we enter bubble territory. It is worth remembering, however, that markets can extend prices well ahead of a solid fundamental driver for longer than many market participants expect.”

Ben Rogoff, Lead Fund Manager of Polar Capital Technology Trust, said: “Perhaps the most important lesson is that while most infrastructure builds end with overcapacity, that doesn’t mean the investment cycle itself should be avoided, nor does it mean we’re in a bubble.

“Even in the early or middle stages of a structural cycle, investors should expect bouts of volatility. We’ve already seen two this year alone, DeepSeek and Liberation Day and they’re unlikely to be the last challenges to the AI narrative. For perspective, between 1995 and 1998, before the dotcom ‘melt-up’, the Nasdaq-100 saw seven corrections of over 15%, during which the index still rose 350%. Volatility is endemic to new cycles; this AI cycle is unlikely to be very different.”

Mike Seidenberg, Manager of Allianz Technology Trust, said: “My job is to make good risk/reward decisions for our investors and this is predicated on an investment process we adhere to. My background is operational and thus very focused on why customers buy things from companies. I am very execution focused, which does not mean I don’t make mistakes, but equally I’m not attracted to the shiniest car on the block. I also have a healthy degree of scepticism as part of my personality. Ultimately, every decision we make is based on risk/return, and this won’t change.”

Craig Baker, Chair of the Alliance Witan investment committee, said: “If you look back to the dotcom era, you’ll see that many of the businesses that led the way then have since fallen by the wayside. Indeed, the leading businesses by market capitalisation in any era are rarely still in the vanguard a decade or so later. So, it can be dangerous for your wealth to place too much faith in a handful of businesses or simply rely on index weightings to decide how much to allocate to them. We believe it’s important to retain a diversified portfolio driven by individual stock selection rather just investing in one dominant theme.”