Getting To The Bottom of The Whole AI Bubble Things

Let's get to the bottom of the whole AI bubble thing. Yes, there's a bubble out there about to burst. And yes, arguments against this can legitimately be held up to the plethora of examples history provides of previous technology bubbles.

Simple to say, isn't it. So why do people sit complacently with their AI investments intact?

We could speculate on this. "Speculate" because we can't really lodge ourselves into the minds of others. Nevertheless, if we try to make sense of why folks keep hanging on, we might make some headway.

Let's start with individuals holding AI stocks in their portfolios, specifically their taxable portfolios, taxable as opposed to "qualified" or pre-tax portfolios. From our professional experience, the issue of "why hold?" lies with the taxable accounts. But let's recap first why that is. 

Qualified portfolios include IRAs, 401ks, 403bs, 457 plans, etc. These were funded with pre-tax money (money not taxed before being deposited into the account). They are tax-deferred. Ultimately taxes will be paid when withdrawals are made, typically in post-working years, a/k/a "retirement." But for now, you can buy and sell securities in them without tax consequence. So those holding AI stuff in these portfolios can sell them without taking a capital gains tax hit. 

On the other hand, the taxable accounts expose you to that cap gains tax. Taxable accounts have been funded with money previously taxed. These are basically brokerage accounts that prudent folks have funded in addition to their "retirement" (qualified) accounts. (Why this is prudent is a story for another day.)

Those holding AI stocks frequently have a low "cost basis" in those stocks. Cost basis is what you paid for the stock. You're taxed on the difference between what you paid for them and what you sell them for. Clients who bought AI stocks early in the game now have a slug of low cost basis holdings. Given the tax exposure, they just don't want to take the hit in taxes. So they hold on.

Is that smart? It is if these stocks will never go down. But if history is any indicator, their tumble could be pretty severe. And with that tumble, losses in the stock price will far exceed any tax that might have been paid in a sale.

We know some pretty smart folks who know this. So why do they still hold on? The only thing that makes sense is that they figure they'll take the hit in price and just keep the stocks for "the long run." Will this work out? It might if they live long enough. And it assumes they'll never need to cash them in for current expenses. So the folks in these circumstances need to be pretty well-to-do if not outright rich.

All of the above suggests that AI stocks will follow their historic predecessors in other technology booms. So to make the above make more sense, it would behoove us to know those precedents.

For that we turn to Ed Dowd. We've followed his thoughts in the investment arena from time to time, for a number of years and consider him experienced, smart and thoughtful. So when we spotted an article articulating this point, we checked it out. There's nothing in his discussion we were not already familiar with. So we're pretty confident that his analysis is spot on. But since he lays it all out and since this post is getting long in the tooth, we'll just refer you to his Substack article. 

To prep you, here are his examples:

- The US Railroad Bubble

- The 1920's Utility Bubble

- The Dot Com Bubble

I think most of us are familiar with the Dot Com Bubble. But what about the other two? It's important to become familiar with them. That's so we don't think of the Dot Com Bubble as some sort of one-off situation. Instead, we should see the "Bubble Pattern" that the AI Bubble may very well emulate. 

We might recall the phrase, "This time is different." It's a phrase that has created much trouble and heart-ache for investors who believed their stuff is safe from previous instances of value destruction. 

In any case, for the sake of protecting your wealth, perhaps even your sanity, do read the article in full. If you're one of those holding what are likely stupendously over-valued AI stocks, and if these comprise a good chunk of your wealth, we think you really ought to understanding what's likely going on here.  

Ed Dowd's article:

https://eddowdbeyondthenarrative.substack.com/p/investment-bubbles-are-a-feature 

At the very least, don't let the financial media jabber and blather (see our last post) distract you from the business at hand.

And if you're of "sensitive" type who's afraid that what you took to be the "truth" about the AI companies as a good current holding in your portfolio, you might consider the message of this gem from the 1960's. 

Hard to argue that "somebody to love" trumps the stuff that can distract, unnerve, and drag you down at times, isn't it?