What the Mainstream Media Gets Wrong About Stock Market Bubbles

“AI stocks are in a bubble! Get out while you still can!”

If you’re tuned into the mainstream press, you’d be forgiven for thinking that artificial intelligence (AI) stocks have risen so high they’re set for an imminent wipeout.

Here’s a sample of some recent headlines…

• AI Mania Triggers Dot-Com Flashbacks – The Wall Street Journal (8/11/23)

• The AI Stock Bubble May Be Popping – Yahoo Finance (8/7/23)

• Every Start-Up Is an AI Company Now. Bubble Fears Are Growing – The Washington Post (8/5/23)

• ‘AI-Driven Bubble’ May Burst and Drag Stock Market Down, JPMorgan Says – Forbes (7/25/23)

• AI Bubble, Fed Hike Fears Have Investors Fleeing Growth Stocks – Bloomberg (6/30/23)

That’s scary stuff… especially the reference to the dot-com era.

After climbing 1,002% in the 1990s, the Nasdaq crashed hard at the turn of the millennium.

Starting in March 2000, the tech-heavy index fell as much as 77% over the next two years.

Investors who piled in at the top of the frenzy… and panic sold their stocks near the bottom… lost their shirts.

So, are AI stocks in a bubble, as so many in the mainstream media are warning?

Or is this a rare opportunity to make potentially life-changing gains in the stock market?

As you’ll see today, this is not an easy either/or question. As long as you use some simple risk management strategies, both can be true at the same time.

That’s why I continue to recommend ways to play the AI boom despite all the dire bubble warnings in the mainstream press.

But before we get into that, it’s important to understand what people mean by a bubble…

Don’t Let Bubble Fears Make You Miss the AI Opportunity

During a bubble, something new, innovative, and potentially world-changing catches investors’ imaginations.

Think of the railroads and the telegraph in the mid-19th century… the radio in the early 20th century… and the internet at the turn of the millennium.

This triggers a speculative frenzy among investors. They send stocks related to this innovative new technology skyrocketing.

Then the bubble pops, and stock prices plunge.

The example most folks are familiar with is the dot-com bubble. Here’s a chart of what that looked like…

Looking at this chart, it’s tempting to think that the best thing you could have done as an investor in the 1990s was avoid internet stocks altogether.

And I expect millions of Americans will steer clear of AI stocks because they fear a repeat of the dot-com crash.

But that’s a mistake. Because if you manage your risk, catching the early years of a bubble is a rare opportunity to make life-changing fortunes in the stock market.

The internet bubble is a great example…

These Bubble Warnings Came Too Early

Warnings that internet stocks were in a bubble came as early as 1995…

One of those warnings was from Ray Dalio. He’s the founder of the world’s largest hedge fund, Bridgewater Associates.

In 1995, he told Pensions & Investments magazine…

I think we’re approaching a blow-off phase of the U.S. stock market. 

Peter Lynch also warned of a bubble in internet stocks that year.

He ran the Magellan Fund at Fidelity Investments between 1977 and 1990. Over that time, it averaged an annual return of 29%. That was more than double the average annual return of the S&P 500. And by the mid-1990s, Lynch was a rock-star investor.

In an article in Worth magazine, he warned that “not enough investors are worried” about the risk of a downturn in stocks.

Or take Howard Marks. He runs Oaktree Capital, the largest distressed debt fund in the world. He prides himself on being an expert in bubbles and market crashes.

And in 1996, Marks warned that frenzied stock trading was taking place. As he put it…

Every cocktail party guest and cab driver just wants to talk about hot stocks and funds. 

A year later, legendary trader George Soros decided the jig was up.

In 1997, he bet that the internet bubble was about to burst. By 1999, his fund had lost $700 million on those bearish bets.

These investors saw that interest in the internet would lead to a bubble. But they were several years too early on their bearish calls. And anyone who heeded their warnings and sat on the sidelines missed out on fortune-making gains.

The Nasdaq rose 42% in 1995… 23% in 1996… 22% in 1997… 39% in 1998… and 85% in 1999.

That’s a cumulative gain of 447%.

And individual tech stocks did even better.

Take Cisco Systems. It makes internet switches and routers. From March 1997 to March 2000, it returned 1,145%.

Juniper Networks was founded by two former Cisco engineers.

It also made routers and other network hardware. It delivered a 699% return over that time.

Chipmaker Qualcomm built the computing power for many of these devices and laid the groundwork for the mobile web. It returned 2,050%.

Or take Dell. It’s best known as a PC maker. But it also sold servers and networking equipment. And it returned 1,089%

Of course, when stocks soar like that, there’s a risk they’ll come thudding back to Earth.

And we now know that’s what happened in the spring of 2000.

That’s why risk management is so important. And it’s why one of the first things I did when I came on board here at Brownstone Research was publish a Risk Management Rule Book.

Two Risk Management Rules to Remember

Subscribers of my flagship tech investing advisory, The Near Future Report, can find the full rule book at the end of my first issue, here.

But don’t worry if you are not already a subscriber. I’ll go over the two most important rules here.

First, every recommendation I make comes with a stop loss.

In the case of Near Future Report recommendations, if a stock falls below the stop loss I set, then we sell – no questions asked.

For example, if I recommend Acme Co. (ACME) at $100, I’ll set a stop loss at $75.

If ACME closes below $75, I’ll send an alert to my readers recommending they sell their shares and close their positions.

A 25% loss stings. But it’s manageable. And by cutting our losers quickly and letting our winners run, we’ll put ourselves in the best position to profit from the portfolio overall.

Second, every recommendation I make has a target price. Once a stock hits that price, I recommend taking profits or raising the stop loss to lock in gains.

Had investors applied the same rules during the melt-up in internet stocks in the late 1990s, they would have been able to capture the explosive upside without exposing themselves to a ruinous loss as the bubble deflated.

And don’t forget, what looked like bubble levels for the Nasdaq at the peak of the dot-com boom don’t look so bubbly now.

On March 10, 2000, the Nasdaq peaked at 5,048 points. Today, the index is at 13,641 points – almost three times that level.

So, investors were undervaluing, not overvaluing, the index at the peak of that supposed bubble.

That’s why I’m not so worried about whether AI is in a bubble.

Like most breakthrough technologies, I expect it will enter a bubble someday. And someday, that bubble will pop.

But ChatGPT launched just a year ago. So, we’re a lot closer to the start of this boom than the end.

To go back to the example of the internet, this is a lot more like 1996 than 1999 or 2000.

And that means double-, triple-, even quadruple-digit gains are possible in the right AI stocks.

So, I’ll be ignoring the fearmongering in the mainstream media. Instead, I’ll be looking for the best opportunities to profit…. and using my risk management rules to limit the downside risk.

Regards,

Colin Tedards
Editor, The Bleeding Edge