Living with bubbles

By Matein Khalid

Bubbles are a recurrent phenomenon in financial markets, from Dutch Tulips in Rembrandt’s Amsterdam to Kuwait’s Souk al Manak, Japan’s Nikkei Dow to the dotcom debacle in 2000, the credit bubble in 2007 to the crypto SPAC roller coaster in 2021 and now the global hype over artificial intelligence (AI).

Is there a bubble in AI stocks even though some have been blowout winners in my portfolio? Yes. Without its undeniable AI dimension, I do not see how 65X forward earnings on Nvidia at 304 can be justified, especially since I remember begging several friends to buy Jensen Huang’s Silicon Valley chip icon at 125 – 130 last July. Yet it is difficult to argue that Meta, another platform beneficiary of AI is overvalued at 20X or Alphabet at 22X forward earnings. True, Keynes warned us that markets can remain irrational a lot longer than we can stay solvent, so a bubble’s parabolic rise and inevitable nemesis can wipe out Joe sixpack and Harry Habibi pronto.

We saw a true Wild West bubble in 1999 when cyclical semi stock like Qualcomm traded at 194X earnings val du jour is now 10X or Cisco Systems traded a loony tune 134X before its flameout. Yet is Microsoft truly in the bubble zone at 31X when it traded in the pre-ChatGPT era at 35X at a time when Azure, Office365 and the Bing search engine will be transformed by its first mover foray into AI? The total addressable market in AI is estimated by tech economists at $170 billion now but industry insiders tell me that AI could well be a $2 trillion global TAM in 2030. This means that AI will definitely be one of the epic money making fiestas on Wall Street even though heart breaks and bear markets mean the ride will not be linear into the broad sunlit uplands (sorry Mr. Churchill) of technology’s Xanadu.

The Americans say that the game is not over until the fat lady sings and I think the debt ceiling sell off was just a perfect gift to load up on beaten down money center bank stocks. So why is Bank of America trading at a Cinderella valuation of 8X earnings and down 24% in 2023, much worse than franchises mired in admittedly deep doo doo like Citigroup or Well Fargo? The problem is that Brian Moynihan miscalculated by allowing his bond traders to load up on a much longer duration than its peers, a shocking 8. So bond losses even if unrealized will hit EPS growth even if BankAm has the world’s biggest, lowest cost trillion dollar excess deposit base and was a magnet for $300 billion in flight to safety deposits during the SVB/First Republic crisis, akin to J.P. Morgan. So the risk/reward calculus on BAC at 27 was a no brainer for me.

A Fed is usually a catalyst for money center bank stocks and I believe we will now see a pause at the June FOMC. True, an inverted Treasury yield curve, rising job losses and anemic oil/metal markets on an iffy Chinese rebound, rising default in consumer loans and horror show in commercial real estate will mute the upside in bank stocks in this cycle.

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Also published on Medium.