VERUM Insights...

Surely faster growth will help earnings catch up to prices, right? No need for the bubble to pop? Today’s stocks may seem cheap when this growth surge is fully realized. Right

 AI can be helpful:

A 26-year-old man charged with brutally killing his roommates before dumping one of their remains in trash bags may have consulted ChatGPT for advice, Florida prosecutors said.

Hisham Abugharbieh allegedly asked the AI chatbot a series of questions, including what would happen to a person if they were put in a garbage bag and whether a car’s VIN number can be changed, the prosecutors said in a new court filing.

This will come as good news to investors. Because, if AI turns out to be the wealth booster that many people expect, maybe stocks won’t be in a ‘bubble’ after all? Maybe swelling growth will make today’s AI stock prices seem reasonable?

If you buy a stock for $10. And the company earns $1 a share...that’s a fair investment. If the company then distributes 50% of its earnings, it leaves you with a 5% dividend yield.

But if the same stock costs $50 it is in bubble territory, where the actual earnings don’t come close to justifying the price. However, if earnings were to rise from $1 per share to $5 per share, the stock would again be reasonably priced.

Earnings growth can justify high prices. Investors typically refer to “PEG” ratios, popularized by Peter Lynch, (PE ratio/Growth) to signal a stock that merits a higher price because of its rising earnings.

You’d think this might be true for the AI juiced stock market as a whole.

We’ve all seen what remarkable things AI can do. It already drives cars; it is just a matter of time before it replaces truck drivers and chauffeurs. It is already replacing assembly line workers, cashiers, clerks and laborers of all sorts. Even the simplest tasks, such as mowing the grass along highways, are now being done by AI-enhanced systems.

In our world — economic and investment research — AI plays a larger and larger role, too. Everyone we know is working with an AI ‘agent’ or ‘butler,’ asking it to sort through millions of pages of statistics, data, and research to find the secrets. What if you knew all there was to know...what would you invest in now? Ask your AI buddy!

Meanwhile, the leading tech companies continue to push the limits. They aim for AGI — Artificial General Intelligence — which can do everything a human can do. The AGI humanoid robot will work 24 hours per day, 7 days a week...and not even ask for a coffee break.

Surely, this is a new dawn for humanity...no? Faster growth will help earnings catch up to prices, right? No need for the bubble to pop? Today’s stocks may seem cheap when this growth surge is fully realized.

That was the claim made for the dot-coms too. And individual dot-com businesses — AMZN, for example — were wildly successful. But the Nasdaq bubble popped anyway...and took 15 years to recover.

Can AI increase a company’s profits? Almost surely. AI will cut costs, lower prices and squeeze profit margins. No need for hours of research to find the best buy. Let AI do it.

(NB: these labor saving, money saving advances will be deflationary, not inflationary.)

But if AI can make companies more profitable...why won’t it bring earnings more in line with stock prices?

Economists have a word for this fallacy — we couldn’t remember what the word was so we asked our AI pal, Claude:

You’re describing the fallacy of composition — the error of assuming that what is true of a part must also be true of the whole, or vice versa.

In economics it shows up constantly. The classic textbook example is the “paradox of thrift,” articulated by Keynes: if one household saves more, it builds wealth and is better off. But if every household saves more simultaneously, aggregate consumption falls, businesses see weaker demand, incomes drop, and total savings can actually decline. What’s rational for the individual is destructive for the whole.

Yes, of course, AI may make the economy more productive, richer, and more dynamic. But as the water level rises, all boats rise with it. Stocks may go up...

But so do wages, competition and GDP itself. And it may take 10-20 years for earnings to catch up with today’s prices. In the meantime, speculators could expect very low returns.

What speculators are really betting on is not general prosperity, but for stocks to rise much faster than GDP. That was the charm of the Funny Money Era...and its curse.

In 1980, near the beginning of the Funny Money Era, the stock market was worth about 75% of GDP. Now, it is 250%. What would happen if the bubble were to pop? Patrick O’Shaughnessy channels Paul Tudor Jones:

Since 1970, we get a mean reversion about every 10 years. Let’s say mean reverts to the past 25 or 30-year PE. That would be a 30, 35% decline. Well, 35% on 250% of GDP is 80, 90% of GDP. 10% of our tax revenues are capital gains, they go to zero. So you can see the budget deficit blowing up. You can see the bond market getting smoked.

In other words, the ‘pop’ could wipe out $27 trillion, or 90% of GDP — a calamitous loss for just about everyone.

So, sorry. No Eden without a snake.