Ark Invest CEO Cathie Wood is known for her big bets in emerging technology trends. As artificial intelligence (AI) takes center stage as the next big thing in tech investing, Wood is making her opinions clear.
In a shareholder letter published earlier this month, Wood proclaimed that a “reality check” could be in store for AI investors. I think she’s right.
Let’s dig into Wood’s concerns and assess how AI euphoria is fueling the broader trends in the capital markets. While there are some underlying risks, investors don’t need to panic. I see many ways to capitalize on the AI revolution, so long as prudent financial judgement is applied.
The artificial intelligence fever pitch
Following a dismal performance in 2022, stocks rebounded sharply last year. The tech-heavy Nasdaq Composite index surged 43%, primarily driven by positive sentiment surrounding the AI narrative.
The euphoria has carried over into 2024, as both the Nasdaq and S&P 500 have set and eclipsed new record levels this year. The upward momentum doesn’t appear to be slowing down, which may have investors thinking that anything related to AI is a good area to place your money.
Not so fast! Let’s take a deeper look underneath the hood.
Less is more
The chart below illustrates the 2023 returns for the “Magnificent Seven” stocks — a moniker used to capture megacap tech companies Microsoft, Apple, Nvidia, Alphabet, Amazon, Meta Platforms, and Tesla.
It’s easy to see that this small cohort of stocks generated eye-popping gains. But considering the S&P 500 returned 24% overall in 2023, there’s something more curious at play here.
Essentially, the Magnificent Seven played a major role in pushing the S&P 500 and Nasdaq higher last year. Another way of looking at this is that most stocks in these indexes either underperformed the broader market or did not rise at a commensurate level to that of the Magnificent Seven.
Look for proven winners
Every so often, new terminology enters the mainstream investing lexicon. Over the last decade, terms such as “metaverse” and “blockchain” each experienced some fleeting popularity. I’d argue that AI is verging on the same trend.
This dynamic carries a lot of risk as it relates to investing. Where things can get dicey is when investors buy into thematic investing.
On the surface, investing into broader market themes through exchange-traded funds (ETFs) or other passive vehicles seems harmless. However, sometimes investors will bypass index funds and try to identify the “next big thing” on their own. This can be problematic as investors will often connect dots that aren’t really there, and blindly take a position in a speculative company that is riding the current wave.
Artificial intelligence is clearly the biggest theme fueling tech investing at the moment. Given how much money is piling into anything even tangentially related to AI, it makes sense that some stocks are benefiting from secular trends as opposed to proven business results.
In other words, many tech stocks are rising for the wrong reasons. Following the hype often carries risk and can leave you as a bag-holder when the music inevitably stops playing.
While there are some real winners emerging in the AI realm, the chart above suggests that the best investments may be a small set. Of course, there are plenty of opportunities beyond megacap tech.
Overall, I think Wood is right in that a lot of capital has been allocated into AI, but only a small portion of this will be rewarded. If you are interested in gaining exposure to artificial intelligence for your portfolio, I would suggest looking into passive funds that carry diversified holdings. Alternatively, you can also take equal positions in the largest, most proven players in the space and monitor performance accordingly.
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Cathie Wood Says a “Reality Check” Is Coming for Artificial Intelligence (AI) Investors. Here Are 3 Things Smart Investors Should Know. was originally published by The Motley Fool