In a booming stock market, hype is all that matters

Don’t toss that SPF 50 just yet. Summer may be fading, but the stock market is still throwing off plenty of heat.

Since the spring, stocks have staged a monster comeback from the brink of tariff-induced despair to the unchecked exuberance we’re seeing today.

The S&P 500 INX index is up 30 per cent from its low point. Canadian stocks, in apparent denial of the country’s economic crisis, have gained 27 per cent.

Everywhere in financial markets is the whiff of excess. Retail investors are all in. Valuations on U.S. stocks are towering. And the artificial-intelligence hype machine has drowned out concerns about tariffs and trade wars.

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It’s starting to feel a lot like 2021, when a booming bull market morphed into a speculative hysteria of meme stocks and non-fungible tokens.

A harsh reckoning soon followed that episode. Is the current cycle doomed as well?

It would be futile to say either way. Markets can continue to rise long past the point one might consider irrational. Only after everything has come crashing down does it become obvious the market was in a bubble.

One thing is clear, however. There will be far fewer winners of the artificial intelligence revolution than investors are currently clamouring for.

When the stock market coalesces around a transformative technology like AI, it’s easy for companies to bask in the glow of the new thing.

Last week, a mattress company called Eight Sleep announced it had raised US$100-million to “build the AI that finally fixes sleep.”

Best of luck to them – and their investors. But they should keep in mind that time sets the bar for success much higher than a euphoric stock market does.

A mass culling in AI is inevitable. A Massachusetts Institute of Technology (MIT) paper that caused a stir in financial markets last week gave a glimpse into this near future. It found that 95 per cent of businesses it studied realized zero return from spending on generative AI projects.

“In most ‘new, new things,’ investors tend to treat far too many companies – and often the wrong ones – as likely to succeed,” renowned investor Howard Marks wrote in his latest newsletter.

Back in 2017, it was blockchain technology that seized the investing masses. In a blatant attempt to cash in on the hype, a New York-based beverage company changed its name from “Long Island Iced Tea Corp.” to “Long Blockchain Corp.” Its stock price soon quintupled.

Companies around the world launched more than 80,000 blockchain projects around that time. By mid-2019, at least 92 per cent of them had failed, according to the China Academy of Information and Communications Technology.

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Blockchain has its practical uses today in the crypto asset space, but it vanished as an investment theme.

In fact, the usefulness of the technology itself is kind of beside the point. The internet really did change the world, but that didn’t stop the stock market from crashing when the dot-com bubble popped.

In the case of crypto assets, which have next to no practical use, hype is everything.

Much like the blockchain freeloaders of 2017, some underperforming companies have taken to simply buying bitcoin as a business model. They are following in the footsteps of Strategy Inc., a software company turned bitcoin hoarder that has amassed US$70-billion worth of the crypto asset.

U.S.-based thermal energy company KULR Technology Group Inc. started buying up bitcoin in November, a move that initially elevated its stock by more than tenfold.

Never mind that crypto has nothing to do with your core business. It’s a foolproof way to attract attention and give a faltering stock a jolt of adrenaline.

In July, a company called CEA Industries Inc., which owns a chain of vape stores in central Canada, announced it was raising US$500-million to buy Binance Coin. Its stock then shot up by 550 per cent in one day.

Doesn’t it feel like this market is starting to give off 2021 vibes, when NFTs of bored apes could go for millions of dollars? It does when you combine the hype with worrying signals around valuation and market concentration. A sampling of some of the indicators:

• The price-to-sales ratio of the S&P 500 sits at about 3.2, higher than the peak of the 2021 bull market
• The ratio of growth to value stocks in the U.S. is at a record high
• The three largest stocks make up more than 21 per cent of the S&P 500, while the Top 10 account for 38 per cent – both are record highs
• The ratio of total U.S. stock market capitalization to GDP – a favourite metric of Warren Buffett – is also at a record high

None of which is a reason to bail on the stock market or veer away from a suitable long-term investment plan.

But it’s worth taking a hard look at just how much of the market’s hype you’re exposed to.