When the most liquid and dominant equities market in the world depends on earnings from just one stock to confirm its strength, investors’ worries are justified.
There was panic this week before the earnings announcement for Nvidia Corp. I do not remember a panic of these proportions in the thirty-three years since I became active with the markets.
What is happening? The short answer is that narratives about artificial intelligence are driving this exuberance.
Narratives about artificial intelligence are nothing new. In the 1980s, there was also a frenzy about artificial intelligence and robotics. I know, because I was working on designing high-speed robots for electronics assembly at one of the biggest companies in the world at the time.
Something good always remains after every bubble. Many dot-com era companies disappeared, and many investors lost fortunes, but the internet changed the world. This time is no different: although the artificial intelligence frenzy may serve a purpose during an election year, something good will emerge from it. However, many investors will probably lose money because the trades are already crowded.
As the chart below shows, the stock of Nvidia Corp. is up 437% since January 3, 2023!
The Magnificent 7 group is up 156%. Yet, the equal-weight S&P 500 and Nasdaq-100 ETFs, SRP and QQEW, are up only 14.5% and 39%, respectively.
Mean reversion is the most powerful force in nature. Nothing goes up forever. The market has low breadth. With interest rates high due to sustained inflation, there should have been a bear market, as the yield curve inversion has predicted.
The artificial intelligence narrative has managed to pump the market and avoid a recession for now. Eventually, when expectations about this new technology become more realistic, fundamental conditions will prevail, and there will be normalization.
Profiting from this new irrational exuberance makes perfect sense. However, many investors think they will be able to time the market.
Historically, most investors exit the market after the bubble bursts with significant losses. We do not know when the top will arrive. Only those with limited experience with the markets think they can identify tops and bottoms. What we can do is use strategies and indicators that have a good track record of limiting losses.
Market timing has the potential to minimize risks. With that in mind, we have developed a dual approach to market timing: hybrid asset allocation. Click below for more details about market timing.
Disclaimer: Investing in any market, including exchange-traded products (ETPs, ETFs, and ETNs), could result in a total loss of capital. No part of the analysis in this article constitutes a trade recommendation. The past performance of any trading system or methodology is not necessarily indicative of future results.