Could an ‘AI Bubble’ Threaten Your Retirement Savings?

Welcome back to Terms of Service.

I'm Sianna and Tech reporter Claire Defi.

AI has been driving a ton of growth in the stock market over the last couple of years,

but there are also concerns that this might not last, and that over-indexing on AI could

lead to big consequences.

Some experts think we could be heading towards something similar to the implosion of the

.com bubble, where technology stocks rose rapidly with the emergence of the internet

in the late 90s and then crashed in 2000.

And I have to tell you, in the midst of covering this, I personally have been wondering,

do I need to be worried about my 401k if this bubble bursts?

So that's what we're going to talk about today.

Is the AI market a bubble waiting to burst?

And if so, how should we all as individuals be thinking about our personal investments

and retirement accounts?

To help me answer those questions, I have Ross Mayfield here with me.

He's an investment strategist for Bayard Private Wealth Management, where he helps clients

make informed investment decisions.

And just to be clear, this is not official investment advice.

This episode is for informational purposes only.

My conversation with Ross after this short break.

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Hi Ross, thanks for being here.

Hi, thank you so much for having me.

So before we get into AI specifically, let's talk about what a market bubble is.

What are some attributes that to you define a market bubble?

A few of the telltale signs of a bubble are one, just prices separating from fundamentals,

right?

Prices going up at a pretty monumental clip and leaving fundamentals of whatever the

underlying is completely in the dust.

So it could be text stocks, it could be the housing market, it could be something entirely

different, but price is going vertical and leaving the fundamentals behind.

And when you say fundamentals, you're talking about like what the business is actually poised

to make, right?

Exactly, yeah.

The earnings of the company, the cash flows of the companies, you know, in the case of

housing, you know, what the cost to build the housing was.

The fundamentals that define a business in this case, which we typically use, you know,

to price companies, to price the stock market to make investments, they should be the

core driver.

And asset bubble tends to pop up when a narrative or kind of a speculative, fervor outweighs

any sense of the fundamentals of the underlying.

So, you know, the modern term is, is FOMO, right?

Like everybody piling in, everybody on one side of the boat.

And there's a sense that this time is different for whatever reason.

And so that narrative and that psychology are really important, but they're also really

hard to pin down.

So that's one of the things we're watching for really closely.

Okay, so price not matching with fundamentals and then this narrative, the speculation,

those are the two big pieces you look at when defining a market bubble or an asset bubble.

Yeah, absolutely.

And there are other things on the margins, right?

You would look for, you know, excessive use of leverage or a lot of, you know, retail

trading and certain asset classes, you know, in the dot com bubble.

And I'm sure we'll talk a lot about that.

There are all these stories about people quitting their jobs to day trade.

It's a little mushy to kind of pin down.

It's not very quantitative, which is tough for analysts like myself, but you're looking

for excess leverage, loose financial conditions, things that allow, you know, what might normally

be just an expensive market or some excitement to morph into something different altogether.

Hmm.

So, for people who might not be familiar, will you give us some examples or an example

of a previous bubble?

Yeah, absolutely.

So, I mean, the dot com bubble of the late 90s is the go to example, particularly for

today, because it's a brand new technology.

It has a lot of promise to kind of change the way that we exist in the world, the way

that we work, the way that we move around through the world.

There were a lot of new companies, a lot of investment into the infrastructure and hardware

that we take to make this come off the ground, ultimately a big run up in tech stocks,

like we're seeing today, followed by the dot com bubble popping in the early 2000s.

So I would say that this also resembles pretty closely the mid 1800s railroad bubble,

which this is my favorite bubble.

Yeah.

It's great, right?

Because railroads are such an old school technology, but in the 1800s, they were the

AI of their time.

It was this game-changing technology you had to build all the railroads, lay all the tracks,

so big upfront investment for an uncertain future.

And then, of course, that comes along with a lot of hype, a lot of charlatanism.

But ultimately, I think the thing that's really important is both of those bubbles and

I think the AI market today were investments in productive assets that even once the bubble

popped had long uses, right?

The internet is still obviously the bedrock of the economy today.

Railroads, the same for the rest of the 1800s and a lot of the 1900s.

It's when you get bubbles in non-productive assets, financed with debt, that can be

really problematic.

So the first asset bubble of all time references the tulip bubble and the Dutch tulip mania,

right?

FOMO, asset prices going straight up, but you couldn't do anything at tulip.

So it was a lot of speculation and fervor for an underlying that had no fundamentals

because it was just a flower.

Yeah, I think that's such an important point that you're making there.

That even when there are bubbles, that pop and cause short-term financial strain on

people.

And that's real, but they can still lead to these investments in future technologies

that are really important.

I mean, we're still using railroads today.

We've heard lots of talk over the past year about this AI bubble.

Are we in one?

Are we not?

Why do you think that is?

Why do you think that so many people are talking about this right now?

You know, in a lot of ways, we're always kind of the general fighting the last war,

right?

Outside of the pandemic, the two big financial crisis that most investors and consumers

experienced in the last 40 years were the dot com bubble and the great financial crisis.

And so this has so many commonalities to the dot com bubble that I think it's just an

easy thing for people to kind of glob on to and look for the similarities and really dig

at it.

And if you look over the last 10, 15 years, I mean, this has been a common thing.

We're talking about AI today, but you know, in Facebook, IPO, it in 2012, there was a lot

of talk about a new tech bubble with these social media companies.

So we've we've really been grabbing onto the themes that we're used to and that we've

seen play out in real time.

Yeah, that's everybody is so worried about it happening again.

We feel like we need to keep talking about it.

So do you think that we're in an AI bubble right now?

I don't.

I'm of the opinion that we're not.

I'll just go back to our definition of a bubble.

I mean, number one, we've had a robust full market prices are up, but really not even close

to what you see in a true asset bubble.

One of our favorite charts to use on this is comparing the NASDAQ today from the launch

of Chatchee BT in late 2022 and the NASDAQ in the late 90s from the Netscape IPO in 1995.

And the NASDAQ is up more than 100% over the last couple of years, tremendous gains anyway.

You slice it and you see that price move and you think bubble.

But then if you look at what a real bubble looks like the late 90s, the NASDAQ was up

over 700% in five years.

So it's not even close.

Today just looks kind of like a bull market.

And the other big thing is it's driven by the fundamentals of the underlying companies, right?

Now, there are exceptions to every rule.

So there are some companies and some slices of the market that do look bubbly to us.

But by and large, the big players at the center of this are really cash rich, really for now low debt.

Very profitable outside of the AI stuff.

They all have core businesses that are extremely profitable.

And then the other thing is there's just not a fervor or euphoria, right?

You certainly, to me, don't see everybody piling up on one side of the argument and saying,

we have to own these companies at all costs.

Tech stocks have had a rough couple of months.

I think that skepticism is really healthy in a sign that we're not in a bubble yet.

And when you talk about the big players that are doing well right now,

give people some examples of what companies are talking about just for folks who aren't following as closely.

Sure.

So I mean, the classic kind of hallmarks of this AI movement are the magnificent seven companies in video,

which is one of on a given day, the biggest company in the world.

That is basically the biggest chip supplier.

They are the company basically laying the railroads for the AI trade.

Everyone buys their chips to do whatever in the AI space that they're going to do,

but they make the best chips, the best semi-conductors.

Then you have your, your apples, your alphabets, your Amazon's, your Microsoft's big,

massive tech behemoths that have a lot of different businesses that have decided in the last couple of years that AI is the future.

And they're going to plunge a lot of money into building out the infrastructure,

either for their own AI tools or for AI solutions to sell to businesses downstream,

your croggers or your Walmart or your public utility companies that might be able to use AI in their own business.

So it's typically the very big tech companies at the top.

Some of them are still private.

So we hear a lot about open AI and chat GPT, lately inthropic and clawed.

Those are big private companies, but still very, very big and important players in this ecosystem.

The examples are helpful because, you know, like a Microsoft, like you mentioned,

they've got this very healthy enterprise software business, powering everybody's work email.

So that makes it easier for them to make these AI investments.

You also mentioned there, though, that there are some outliers,

some exceptions to this rule that look a little bubbly.

What are you talking about there?

Well, I mean, if you just look at, you know, the biggest 50, 100 tech companies,

you'll see companies like Nvidia and Microsoft that despite, you know,

all of the hype around AI are trading at, you know,

relatively normal valuations for them.

And then there are a handful that look a bit more expensive, right?

And that's, you know, they could grow into those valuations.

But if you look at, you know,

a Palantir is an example of a company that has a very loft evaluation.

And this is not a judgment on their business,

but just saying that consumers are a lot more excited.

They've bit up the company to a much higher price versus their earnings

and some of these other companies.

And they are very inherently linked to AI.

That is, you know, their core competency in a lot of ways.

I want to break this down and talk about some of the trends in the AI market

that have contributed to these bubble worries and conversations.

And one of them are these circular funding deals.

For example, a chipmaker like Nvidia investing in an AI company,

like OpenAI in exchange for OpenAI saying, Hey,

Nvidia, we're going to buy a bunch of your chips.

Do those deals concern you?

I think they bear a very skeptical and close watch.

They don't concern me outright.

I don't think there's anything inherently shady or suspicious

about vendor financing, you know, these sorts of arrangements exist

in all sorts of other businesses.

You know, if you think about taking out a loan from the finance arm

of a car dealership to buy a car, I mean, that is on a very micro sense vendor

financing.

I think the skepticism and the kind of close eye that investors have

paid to these kinds of deals, again, as a sign that we're not quite in a bubble.

But anytime this sort of circular financing is used to explicitly obscure

or inflate revenues to then raise money at some higher multiple.

And companies more broadly tapping debt markets rather than using cash flow

are the two things that really at this moment in time, particularly,

I would say you watch the most closely.

They can get to extremes where all of a sudden when everything unwinds,

the relationships are so interlinked that everything comes down at once.

Yeah.

We've also seen these reports about companies who pilot AI tools

aren't necessarily seeing a significant impact to their bottom line.

Is that a sign that AI might not be as valuable and revolutionary

as Silicon Valley says it is?

Or are we just sort of too early in the game here to really judge?

I think we're a little too early in the game.

You know, this is kind of a common theme if you go back to past bubbles

and new technologies, right?

The internet was the same way it takes a while to get to an adoption point

where things really inflect and change.

And if you think about Chatchy PT November 30th, 2022,

the gains that have been made in these models just over the last three years

are incredible.

You know, even in recent weeks, the specific products that some of the companies

have rolled out for legal, for logistics that have really hurt some of the legacy

stocks in those industries is a sign that we're moving rapidly towards enterprise

tools, paid tools that can really improve worker productivity in a business.

So we're seeing a lot of adoption and personal use.

We're just a little early to see the inflection point where companies start

to really see productivity gains and profits expanding from, you know,

the AI portion of their business or the AI tools that they implement.

I really don't doubt or have a lot of doubt that it that we're going to get there.

Yeah.

Well, and something that you and I were talking about a few weeks ago that was

really helpful for me and just thinking about how to contextualize this is

that so many of these AI tools, as you said, are geared towards making

workers more productive.

And that's kind of a tricky thing to measure, right?

Like companies may just not have been able to figure out how to have that show

up in their bottom line at this point.

Yeah, 100% not every business function has perfectly measurable KPIs that

you can, you know, see a noted uptick in a lot of it is on the margins.

Maybe it's you are able to produce 10% more, you know, written content or

save some time and summarizing a meeting.

And these are little things, but across a medium sized company over a couple

of years across an industry, across the economy, they compound into,

you know, huge numbers of productivity enhancements and savings.

But it is not the kind of we flip the switch and we immediately saw

XYZ happen.

It's a little mushier.

After the break, Ross and I get into how reliant the broader economy is on

the success of AI and the risks for all of us as individuals if it doesn't

live up to the hype.

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AI has been responsible for a significant percentage of the larger stock markets

growth and US GDP growth over the past year.

The magnificent seven tech stocks that you were talking about, Google, Amazon,

Apple, meta, Nvidia, Microsoft and Tesla account for around 35% of the S and

P 500 estimates for how much AI related investment added to US GDP last year

range from 40 to 60%.

What does it mean for all of us that so much of our economy is being held up

by this one industry?

Well, in one sense, it means that it better be real, which is a, it is a bit of a

scary thought at times.

But I do think that anyone who's used these tools or played around with them

in a business sense knows that we've moved past that question.

I do think there's fair questions about whether when we think about GDP and how

this flows into GDP, it's building data centers.

It's boots on the ground, construction of non-residential investment.

Is there a strong ROI on that building?

If we look 10 years back, was it a good investment?

You know, that's really up to the companies putting the money into it.

I would say that the way we look at the economy from a 30,000 foot view is we

sell a pretty solid labor market.

Consumer spending is still contributing a nice percentage to GDP.

It's almost like a cherry on top that we're also getting this boost from a huge

build out of artificial intelligence.

I don't think the economy is too concentrated in AI.

The stock market might be a different story.

I mean, we are at levels of concentration in the cap-weighted index is like the

S&P 500 that we really haven't seen since before we have data, right?

You can go back to like the 1910s where it was a handful of huge banks and

railroad companies, and that was it.

But even compared to the late 90s, the concentration in the big tax

stocks at the top of the market is pretty historic.

You know, it's not something that we overly worry about,

but it's something that we definitely build guidance around for our clients.

Because I think that is the point where you can see it right now with some

of the tax stocks selling off that it can really hurt people, you know, regular

investors.

I just want to break this down even further because this is a really important

point. What Ross is saying here is that if you own a product that gives you

exposure to the full stock market, a lot of people's retirement funds are set

up this way so they don't have to be super active investors.

A large percentage of the value of that investment is probably tied up in

tech stocks, which is great if the tech stocks keep growing, but could be

risky if the AI market declines or crashes.

And it's important to weigh that risk against where you're at in life and

your own personal risk tolerance.

Understanding that you don't think that we're there right now, if the AI

market were a bubble that burst, what could that mean for people's individual

investments?

Like what are the sort of stakes here for individuals?

I'll take the question a couple ways.

I mean, number one, if you just look at the dot com bubble again, it's the easiest

corollary, you know, the stock market sold off 50 ish percent tech stocks sold

off more over the course of two, three years.

It was a pretty long and drawn out bear market, even compared to, you know,

the great financial crisis, it holds right up there in terms of financial

market pain.

So that would be a big downturn for most folks portfolios.

And now again, as I mentioned up top, we're not even close to the heights of

the dot com bubble.

So there might be, you know, if the bull market were to end tomorrow, I think

the downside would be quite a bit more limited.

I think the good news is, you know, if you think about another bubble in recent

memory of the housing bubble, when that bubble popped, not only did equity

markets sell off and people felt it in their 401ks, but because it was so

interlinked into the broader financial system, it led to, you know, the biggest

economic downturn in 50 so years.

The recession that was associated with the dot com bubble popping was pretty

mild.

There was job loss in the tech sector, but it really wasn't a bad recession.

So for normal people with 401ks, there's the financial pain that could come

if a bubble pops, and then there's the question of how interlinked is it into

the broader economy?

And what could that mean for, you know, jobs that help care sector places that

are totally unrelated to this?

I think we're pretty safe on that front, especially versus, you know, 2008.

And this is sort of on the flip side of what we've been talking about.

But it came into my mind as you're talking about some of the benefits that

we've seen from AI tools recently.

If AI lives up to its hype, does that also pose an economic risk in terms of

reducing the value of existing companies or taking away human jobs?

You know, this is kind of the foundation of which our economy is built on, right?

Which is competition, creative destruction, you know, industries come and go.

But at the end of the day, you're hoping that the new technology will expand the

pie, right?

We've had a lot of new technologies over the last 100, 200 years.

They've changed the way the economy looks drastically.

But no new technology has ever really been a net reducer of jobs.

They've changed where the jobs are, maybe physically, maybe in what industry.

But we've never had a new technology that has net reduced jobs because again,

new technologies typically enhance productivity, open the door to new

industries that are hard to even imagine, expand demand, and the economy kind

of reorient itself, same, same for companies, right?

The big companies from the 1970s and 1980s are not the big companies today.

But that hasn't changed the fact that the stock market has gone up.

We've had these new companies arise in new businesses.

So it's not always smooth and it can occasionally be painful.

But I think that the system we we live in kind of demands that competition

and again, creative destruction and, you know, up until this moment,

it hasn't resulted in the kind of net loss of anything meaningful.

So I can't make a prediction about what the world's going to look like in 10

years with these AI tools.

I couldn't have made a six month prediction based on how fast things are moving.

But I have confidence in looking to history and knowing how new

technologies have impacted things in the past.

Yeah, I think that's such a helpful perspective.

I mean, if you just look back to the internet emerging, we didn't have

Facebook. We didn't have Uber.

We didn't have Airbnb or DoorDash, like all of these companies that make

up such a big part of our lives now didn't even exist because we didn't

have the technology yet.

So I think it's an important point that you're making and a hopeful optimistic

one, too, that like things will emerge out of this AI move that are not

just people losing their jobs.

A lot of our wealth management clients are older, closer to retirement, and

the kind of tongue in cheek example I like to use when I'm talking to them is

the idea of social media influencer as a job, right?

Because it gets laughs in the room usually or or eye rolls.

But that's an industry worth hundreds of billions of dollars.

People want to do that job.

People are getting rich doing that job.

And as you mentioned, couldn't have existed until, you know, the 4G smartphone,

which couldn't have existed if the groundwork of the internet wasn't laid in

the late 90s and early 2000s.

So we don't have to know what the future is going to look like to trust that

the pattern will somewhat repeat itself.

Yeah.

How should people be thinking about and approaching their investment strategies

to balance their risk here?

Like how exposed should we be to these AI companies to obviously get the

benefits of the growth that we're currently seeing while still hedging a little

bit if we need to?

Yeah, this is to me very much dependent on kind of where you are in your

investing, working life cycle.

If you're early on and you have a high risk tolerance and you're just trying to

create wealth, if this becomes a bubble, bubbles are great places to make a lot

of money, right?

As I mentioned, you know, the NASDAQ in the late 90s up over 700% in five years

is, I mean, that's stunning.

Even after the bubble pops, you're still up significantly, you know, over,

over, say, 10 or 15 years span.

So if you have a longer time horizon, a high risk tolerance, I think you

can lean in.

If you are in retirement or you're much more in the protect my nest egg part

of your life, and maybe especially if you don't quite have a good sense of

how exposed you are to AI because of the concentration in the market that we

talked about, I think hedging and diversification are going to be as big a

theme over the next decade as they were not a theme of the 2010s, right?

In the 2010s, if you own large cap growth and a lot of these tech companies we've

talked about, you were good.

They were like the only show in town.

Today, we're seeing gold work, we're seeing international stocks work, we're

seeing bond stage of rebound, just within the US stock market, as tech stocks have

sold off, you know, we're seeing banks work, we're seeing industrials work,

speaking of railroads, we're seeing freight and railroads work.

So there are a lot of non tech places to put your money to make sure that

you're diversified so that if this does become a bubble or even just a regular

downturn, right?

2022 tech stocks got crushed.

That wasn't a bubble popping.

That was higher interest rates and some other factors, but it would have really

hurt someone overly exposed to those names.

So there are a lot of easy ways to diversify and make sure that you're not

overly exposed to one trend if that's money you're counting on in the next

couple of years.

Well, Ross, this is so helpful.

I really appreciate your time and walking us through this in such an

accessible way.

Thank you so much.

Thank you for having me.

It's been a blast.

So if you've been hearing and worrying about an AI bubble, Ross says you can

breathe a bit of a sigh of relief.

Although there's lots of growth and excitement, the behavior in the markets

does not yet look like what we've seen in past bubbles.

The point of this episode is also definitely not to encourage anyone to go

try to start day trading and predicting market trends, but it is worth being

aware of what percentage of your personal investment or retirement portfolio

is made up of tech stocks.

If you're nearing retirement and are going to be relying on that money soon,

Ross says you could consider diversifying.

Of course, it's always a good idea to talk to your financial advisor for the

best advice on your portfolio.

That's all for this week's episode of Terms of Service.

I'm Claire Duffy.

Talk to you next week.

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