More than 180 years after the first railway boom, investors betting on artificial intelligence (AI) are likely on track for a repeat bust performance, according to Robert Almeida, MFS global investment strategist.
In a recent note, Almeida says the current AI enthusiasm bears all the hallmarks of classic behaviour at the crash-end of the capital market cycle.
He says the recent rush of money into technology companies on the back of AI dreams has set the stage for disappointing returns.
“Since equity is currency, the massive outperformance of select well-known large-cap technology stocks signals the direction of the capital cycle,” Almeida says. “The history of capital cycles tells us this won’t end differently than other periods of capital excesses.”
Previous stock market binges on UK railway companies in the 1840s or the more recent internet stock boom of the late 1990s, for example, ended in excess supply and plunging returns on capital.
“I’m not dismissing the enormous potential economic or financial benefits that AI may bring,” he says. “But I’m challenging the idea, implied by their lofty stock prices, that the incumbents can achieve lofty returns on capital and that they’re immune to new competition and ingenuity. There are avoidable risks in many technology companies today, yet investor focus is elsewhere.”
Distracted by AI hype, inflation and interest rates, many investors are also missing out on opportunities in less “glamorous” but more dependable “supply-constrained” sectors, Almeida says.
“We can find numerous examples among suppliers to large end-manufacturers. Prerequisites are typically a good or service that is indispensable, hard to duplicate and not overly costly,” he says. “We see these opportunities — not only today but over cycles — in suppliers to life sciences, residential real estate and the automotive industries, among others.”
However, the veteran MFS strategist notes the changing market dynamics should favour active management over indexing in the years ahead.
“… I believe the success of passive and the capital cycle are linked,” Almeida says. “Passive portfolios are rooted in the past and based on where capital has already flowed, not where it will flow next.”
And sometimes the capital can flow full circle.
“Over a century after the railroad industry crashed and consolidated, the industry now finds itself made up of above-average-return businesses,” Almeida says.
Choo-choo.