According to the Bank of America, via the ever-readable "Daily Chartbook”, Artificial Intelligence (A.I.) stocks are now in bubble territory:
"Baby bubble. “BofA said AI for now is a 'baby bubble,' noting that in the past bubbles always started with ‘easy money’ and ended with rate hikes.”
Is this investible?
First, let’s interpret the Daily Chartbook quote. My take would be:
The general financial conditions for bubbles are not good at the moment — no “easy money”. But they may change within a few weeks or months.
If this is really a bubble, then it’s in a really early stage right now — and that may be the best time to get in!
And anyhow, there is so much funny money sloshing around nowadays, just waiting for an edge. It may not really matter whether current conditions are ideal: those billions will jump in when the sharks smell blood.
But what about Sir Isaac Newton?
Bubbles are notoriously difficult to profit from. The problem with investing in financial bubbles is that we fall in love with our own success. 100% gains in one year? Why, I’ll just ride this one out for another 6 months with triple leverage, and then I’ll be rich!
Can’t happen to you? Well, it happened to one of the smartest persons who ever lived:
So, for all of us who are not more intelligent than Newton, my advice would be: find a rules-based method to invest in bubbles, and stick to it, strictly. So that your greed won’t quite as easily conquer your brain, making you go for broke, despite your very best intentions.
Here’s my idea:
Over the past months, I have been trading Bitcoin with a very simple moving-average setup: buy/sell according to the 30 day simple moving average.
The same setup using the BOTZ A.I. ETF from 2017 onwards would have gained 20.4%, with a maximum drawdown of -17.51%. No great shakes I admit, but remember -- we are yet only talking about a mini-bubble, which will hopefully turn into something a lot more frizzante.
Yes, BOTZ is something of a mongrel, and does include a lot of robotics companies. Fun fact: it was suggested to me by an A.I. chatbot:
The other suggestions, IRBO and ARKQ, haven’t been so successful yet. Beats me whether past performance indicates future success!
With unfortunately only a short history, I also like AMOM: from 2020 onwards, CAGR 20.37%, maximum monthly drawdown -7.23%.
So, how did this scheme work out in some previous bubbles?
Dotcom Bubble 1997- end of 2000:
CAGR 28.94%, max drawdown -14.02%, worst year -15.52%.
(For this, since QQQ wasn’t available back in the day, I used a proxy for the QQQ ETF: FOCPX).
This compares favorably with buy-and-hold: CAGR +18.15%, max drawdown -37.13%, worst year -26.81%.
Biotech Bubble 2013-2017:
Using the ETF XBI: CAGR +9.53%, maximum drawdown -23.75%, worst year -10.27%.
Buy-and-hold arguably fared better: CAGR +24.33%, max drawdown -43.59%, worst year -15.45%.
The “arguably” bit is arguable, however. To my experience, anything with a drawdown of a lot more than -20% means you’re opening up a can of worms. As you approach -30% territory, you tend to panic, abandon your strategy, and sell at the worst possible time. So hi-gain, hi-loss strategies blow up, if not on paper, then in real life. Just ask Sir Isaac!
ARKK 2016 - end of 2021:
CAGR +30.47%, maximum drawdown -22.73%, worst year -11.49%.
This compares favorably with buy-and-hold: CAGR +30.65%, max drawdown -30.6%, worst year -23.38%.
Discussion, and the usual caveats:
Yes, the above data is after-the-fact. Things look differently if you had started investing in the Nasdaq in 1994, and had only thrown the towel in 2002. But my tests seem to confirm that in almost all cases, buy-and-hold is inferior to a rules-based system. Not to mention, the psychological problems inherent to buying-and-holding a speculative asset.
I won’t knock other moving average setups and gladly await your suggestions. But the usual 200-day moving averages seem to be more appropriate to a steady, strongly trending, comparatively unfrothy asset such as the S&P 500. You want to leave an investing fad as soon as it gets out of style.
Personally, I am as of now invested in BOTZ. Skin in the game and such. But only with a small amount. Please don’t get crazy with this, and above all don’t complain to me if you do!
And please remember, if you will, what us Germans say: “Gier frisst Hirn” (Greed eats brain).