Perhaps it is time to withdraw from the artificial intelligence (AI) market and turn to the Dow Jones Industrial Average.
The gap between the promises that AI wants to fulfill and what it can actually deliver remains substantial, which may also be a significant issue for investors. AI has made many promises, suggesting a future where humans no longer need to fill out forms, order takeout, or drive cars themselves. Humans might either end up like those in the movie "WALL-E," reclining in lounge chairs while robots do all the work, or face a scenario like in "The Terminator," where robots attempt to annihilate humanity.
AI stocks have been a major driving force behind the S&P 500's rise this year, whether it's NVIDIA (NVDA), which manufactures AI chips, or Microsoft (MSFT), which benefits from its collaboration with ChatGPT and the use of AI technology in its products. Apple's (AAPL) stock rebounded after a "slow start," partly due to investor hopes that this technology could create demand for AI-supporting iPhones.
Investors previously only needed to know one thing: as long as AI stocks were rising, the stock market would rise as well.
However, there are signs that the risk-reward ratio of AI stocks is not what it used to be. For every company like C3.ai (AI) that sees its stock price soar by 19% after reporting a loss lower than expected, there is a company like UiPath (PATH) that experiences a 34% plunge in its stock price after announcing revenue guidance below market expectations and unexpectedly declaring the CEO's resignation.
Furthermore, for every company like HP (HPQ) that sees its stock price rise by 17% after reporting earnings that exceed expectations and promoting its "innovative solution portfolio designed for the AI and hybrid era," there is a company like Dell (DELL) that suffers a 22% drop in its stock price after reporting earnings that are just one cent higher than expected, which is clearly insufficient for Dell, given its 80% increase over the past three months.
Throughout the earnings season, betting on individual AI stocks has been a high-reward, high-risk investment. Dennis DeBusschere from 22V Research noted that since the release of ChatGPT4 in 2022, 86% of "AI application" companies have exceeded earnings expectations, a higher proportion than the 78% of other companies in the stock market.
When earnings exceed expectations, AI stocks also see a higher increase than other "ordinary" stocks that have also exceeded expectations. In the first quarter, the average increase for AI stocks after announcing earnings that exceeded expectations was 0.3%, compared to an average decrease of 0.3% for other stocks after announcing earnings that exceeded expectations.However, when artificial intelligence (AI) stocks underperformed earnings expectations, they fell by an average of 5.3%, while other stocks that missed earnings expectations saw an average decline of 2.5%. Debuschere explained: "This is because AI stocks have a higher beta coefficient when their earnings are higher or lower than expected."
However, in terms of the overall stock market, only one AI stock is truly significant, and that is NVIDIA. Data from Evercore ISI shows that when NVIDIA announced its earnings on May 22, its stock price correlation with the S&P 500 index was 0.95. Over the past year, the trend of NVIDIA's stock and the S&P 500 index has been almost identical, although correlation and causality are not the same thing, but in the case of NVIDIA and the S&P 500 index, this correlation is almost equivalent to causality.
But in the last few trading days, something has changed. On the first trading day after the earnings announcement, NVIDIA's stock rose by 9.3%, which is quite astonishing for a company with a market value of over 2 trillion dollars. Debuschere from 22V Research pointed out that NVIDIA's earnings report also boosted other stocks, such as chip stocks like ASML, AVGO, MRVL, and TSM, industrial stocks like ETN, TDG, and JCI, and utility stocks like CEG and VST.
However, on the first trading day after NVIDIA's earnings announcement, the S&P 500 index closed down. Debuschere said: "The momentum of the AI trade is very strong, but the AI trade that has detached from NVIDIA's earnings report has not been able to drive the entire market up."
This is a worrying phenomenon. Julian Emanuel, a strategist at Evercore ISI, pointed out that NVIDIA's stock rose by 20% within three days after the earnings report, while the S&P 500 index fell slightly (less than 1 point).
The third largest stock in the S&P 500 index by market value has risen so much, and the index has hardly changed, which has left Emanuel very confused, so he tried to find another example to illustrate that at least the top five stocks in the S&P 500 index have risen so much and the index has closed lower, but he did not find such an example.
Emanuel said: "NVIDIA is no longer 'the stock that can represent the stock market', which may lead to the end of the low volatility in the stock market in the past two weeks."
The calm of the stock market seems to be broken. Last Friday (May 31), the VIX fear index rose from 11.93 on the previous Monday to 14.51, and the stock market, which has been very dull, has made some noise. As the stock market loses its upward momentum, it may be time to consider withdrawing from the AI trade and turning to the Dow Jones Industrial Average.
Nothing is more "contrary" to the AI-driven market than the Dow. NVIDIA is not a component of the Dow, and in addition, because the Dow is a price-weighted index, the largest stocks in the Dow are UNH and GS, Microsoft ranks third, and Apple is in the middle, sandwiched between JPM and BA.
No wonder the Dow has only risen by 1.2% this year, far less than the 9.3% increase in the S&P 500 index and the 10.3% increase in the Nasdaq Composite Index. Recently, due to the poor performance of UNH's earnings report and the disappointing earnings report of Salesforce (CRM), the Dow has been hit hard. (To be honest, Salesforce should not have replaced Exxon Mobil as a component of the Dow.)The founder of Bear Traps Report, Larry McDonald, noted that the Dow Jones Industrial Average has fallen 4.7% since breaking through 40,000 points on May 17th, and closed at its highest oversold level since September 2022 last Thursday.
The Dow may not be the choice of robots, but if the artificial intelligence (AI) market has reached its end, investors who stick to the AI trend may perform even worse than the Dow.