Views #226 - Back to the Future?

I must say I don’t remember if I’ve ever used this movie before (I only saw the first one, although I know there were two more), but somehow this week I felt the need to reflect on the incredible move financial markets have had recently.

In Back to the Future, Michael J. Fox goes back to the past accidentally whilst he is saving his life in a car designed by his doctor friend and then has to figure out how to come back from there. In addition, he wants to make sure he saves his best friend and scientist, and eventually succeeds, and gets the added bonus to come back to the future having made things better for himself and his family. I used to think that time travel was based on the idea that you can’t change where you go, but I guess Hollywood always has other thoughts. I digress as usual.

The reason I bring this up is that, as I wrote recently, I believed we were in the middle of a raging bull market that was probably going to continue to reach new highs and frustrate many people. In general, this trend continued. As usual better be lucky than smart.

But underlying this bull market that we see in indices and certain sectors, there is an incredible dichotomy. On one side, anything related to the build-up of AI — or adjacent areas — has seemingly infinite demand. On the other, the rest is a combination of being massively derated, forgotten or ignored. Of course, the build-out of AI incorporates not just data centres, but all the related components such as power and supporting industries. On the other side it is software related, private credit beneficiaries and related. 

Most recently and triggered by the incredible success of Claude and its related products (they are amazing!), and the reported insane revenue growth at Anthropic, excitement has grown further. The dominant narrative among AI specialists is that despite all the investment made to date, we are still very short of computing power — and therefore the investment cycle needs to continue at this incredible pace. Give that my Claude stops me from working routinely, I can see where they are coming from.

The common view is that if you can bet on the infrastructure, you don’t need to bet on who wins. That has led to skyrocketing performance across the whole range of the semiconductor sector (old and new) and related industries, obviously funded by people selling the rest. It has also led to a re-emergence of the Mag 7 as a reasonable destination for capital — they are the best companies in the world and are all investing aggressively in the sector. This performance gas been across both public and private markets. Like water it has reached every corner that you can.

So why Back to the Future?

AI is, without question, the future of how we will interact with technology. First through computers and mobile devices, and eventually through robotics that will continue to improve and become more versatile. So, we are definitely moving into the future. We will be using it more and more in all aspects of our everyday life. I am a firm believer of that.

But the reason we are also “back” is because the way financial markets — and optimistic investors — are approaching it is very reminiscent of previous periods of financial delirium. And somehow, it is pretty likely that we know how this ends.

I don’t think there has been a time where so much money has been invested so quickly by such a limited number of actors, with very limited visibility on how the business will evolve. That fact alone should give us pause. Speed and thoughtful, efficient investment don’t always go hand in hand. This might be the exception — but I would probably take the other side.

Even though the fundamentals justify many of the initial moves with great revenue growth and profitability in infrastructure related sectors, the speed of progression should make people wonder — even if the direction of travel is right. I have never seen so many people convinced that what we are witnessing is disruptive at a level we have never seen before, and at the same time rely on non-disruptive valuation metrics to feel comfortable with their positioning. The moves in certain large stock sin the last few weeks is breath taking.

Even Elon Musk — someone who I think understands these developments better than most — valued xAI at $250 billion and then decided he needed to spend potentially up to $60 billion on another company to do what xAI was supposedly already doing. And the market thought that was smart.

I find myself constantly needing to be defensive about the fact that I am a huge believer in the technology, but that certain parts of the market — both private and public — are in the middle of an insane and typical liquidity bubble that always ends the same way. I am not against AI, but I want to make money more than I want to feel part of the cult.

Don’t get me wrong — the fortunes that have been made by betting on AI are colossal. Just look at the value creation of companies like OpenAI, Anthropic, and hundreds of smaller players. I certainly wouldn’t have minded being involved in many of them. But mark-to-market wealth eventually needs substance to survive — and in the financial world, that means cash flow and profits.

If you misprice a product, you can grow revenues massively — but eventually you need to address that.

Meanwhile, while people are chasing these sectors at any price, the broader situation in financial markets has become more complex due to the impact of the war. Rates are higher, many commodities are materially higher, and the full effects of these disruptions are still to be seen. Given current deficit spending and financial conditions, the growth picture might still look okay — but eventually the environment matters for markets.

This week we get earnings reports from some of the most incredible companies in the world (five of the Mag 7), and my expectation is that they will remain solid and continue to say they need to keep spending at this rate. I actually think companies like Meta and Google are already benefiting from AI improving their advertising algorithms — making sure we are even more addicted than before 🙂

So it is a little aggressive for me to write a more negative piece right now before I know what will happen, but a)the risk of looking like a fool has never stopped me from doing anything (no need to add more here), and b) If I only write about things that have already happened, it’s really not that interesting.

So, beware: although we are moving quickly into the future, I think we might have a financial episode similar to the past — where markets brutally reassess not the technology, but what is priced in. If that happens, given the size of these sectors and the magnitude of the capital appreciation we’ve seen, it won’t be pretty.

Like in previous periods, it might lead to people reallocating capital elsewhere — but the first move might be very painful on the downside.

Of course, I could and most probably will be wrong, and profitability might surpass expectations — and the moves we’ve seen will not only be justified, but, as some argue, just the beginning. Polymarket probably thinks this is the most likely option. So, keep that in mind.

But I don’t think it will be that straightforward. My raging bull analogy is done. I am now worried about going Back to the Future.

In the movie, the main character warns his friend about what might happen. When he returns from the past, although he is not able to fully change the outcome, his friend — the doctor — has taken precautions and saves himself (spoiler alert).

Financial markets don’t tend to have Hollywood endings. So be careful, and don’t be too greedy. Over time, markets tend to go up and great companies do well. But as Keynes said:

“Markets can remain irrational longer than you can remain solvent.”

You can apply that to me being too cautious today. I haven’t been fighting this — just not fully on the ride. But if we move into the more negative scenario, remember that this quote also applies on the way down.

Thoughts, as always, welcome.

Edward

PS - as usual this piece was written by me, and I used AI for my editing! They did question how I could be writing something not positive about the sector....:-)