Is the AI Party Over? 5 Drivers for the Next Surge

Innovation Drives Bull Markets

Every major bull market cycle in history has had a ground-breaking industry at the heart of innovation. For example, in the late 1800s, railroad stocks dominated as investors sought to take advantage of the first interconnected economy, catapulting Cornelius Vanderbilt to excessive wealth.  A century later, investors scored by exploiting another form of interconnectivity for the first time – the internet. As the personal computer went mainstream, Dell (DELL) computer found itself in the right place at the right time. Shares of Dell gained 216% in 1997 and 248% in 1998. By 1999, mobile phone technology and 3G networks took the forefront, launching Qualcomm (QCOM) shares on a mind-boggling 2,620% gain in a single year. In the heart of the COVID-19 pandemic of 2020, Etsy (ETSY) gained 302%, as newly laid-off people stuck at home flocked to its unique e-commerce model built on independent creators. Meanwhile, in that same year, Tesla (TSLA) shares were electrified by 743% as EVs became mainstream and Tesla turned on the profit spigot.

Is the AI Boom Behind Us?

Real estate, energy, and electric vehicle stocks are some sectors driving the current bull market. However, the largest, game-changing innovation driving money into the 2023 bull market is the advent of the AI revolution. At the top of the heap are Alphabet (GOOGL) and Microsoft (MSFT), which have the most popular Chatbots on the market. Meanwhile, stocks that power the back-end technology, like Nvidia (NVDA) and Oracle (ORCL), have arguably benefitted the most thus far. Nevertheless, many AI stocks have recently pulled back sharply and underperformed the market. Has the bubble popped? Below are 5 reasons AI stocks still can go much higher:

Pullbacks are a Feature, Not a Bug

Savvy investors know that the most sustainable trends include pullbacks. In other words, stocks that trend and “hug” the 50-day moving average tend to go further than those with quick, wild spikes. Usually, a stock will form 4 to 5 base structures (pullbacks to the 50-day moving average or below with a length of 5 weeks or more, <25% in depth) before finally topping and resetting with a larger correction. When Tesla gained more than 700% in 2020, it had four base structures.

Back to the AI stocks. AI winners such as ORCL, NVDA, and MSFT are in the process of creating their first base structures since breaking out earlier this year.

Market Digestion

Like individual stocks, the general market cannot go up in a straight line. The major indices are retreating to their 50-day moving averages for the first time all year. While the pullback may feel painful to amateur investors, such pullbacks are normal and necessary in bull markets. Even the strongest groups, like AI, tend to follow the market’s direction – hence the recent retreat. However, the market may be ready to turn.

Grow Into EPS?

Companies like Nvidia have massive EPS estimates in the coming quarters. Some investors may be waiting to see if AI stocks like NVDA can actually execute and grow into their (perceived) lofty expectations.

Money Gravitates Toward Leaders and Away from Laggards

When a novel technology like AI emerges, investors often invest first and ask questions later. However, as the rally continues, investors gravitate toward profitable, institutional quality stocks and away from speculative, unprofitable companies. On the profitable, institutional quality side would be a stock like ORCL. Conversely, an illiquid, lower quality penny stock like SoundHound AI (SOUN) is less likely to have staying power. 

Market Maturity & New Products

It’s so early in the AI revolution that it is unclear who the ultimate winners will be. Remember the internet craze? At one point Yahoo! and Ask Jeeves, were the leaders in search. When a significant innovation hits the marketplace, innovation takes time and can last years. Be patient and open-minded.

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