The Nasdaq is on track for its best first half in 52 years due to what Forbes calls AI-fueled "market euphoria." It's eerily reminiscent of the Dot Com boom, and if history teaches us anything, it's that market bubbles eventually burst.
A quick history lesson...
After the Internet debuted to consumers in the early 90s, the stock market experienced a rapid influx of new capital into Internet-based businesses with names ending in ".com," causing the tech-heavy Nasdaq to reach a record-high above 5,000 in March 2000, doubling its value from the year prior.
But like all bubbles, the Internet was destined to burst, and the fallout was severe. By October 2002, the NASDAQ had lost 78% of its value falling from 5,046.86 in March 2000 to 1,114.11.
Four things defined this crash:
- Overvaluation and Speculation: Many internet companies were grossly overvalued. Investors poured money into any company with a ".com" in its name, ignoring traditional valuation metrics.
- Lack of Profitability: Many new ".com" businesses were not profitable and had no clear path to profitability. Of nearly 500 companies that went public in 1999, 77% were not profitable.
- Increase in Interest Rates: The Federal Reserve started to increase interest rates in 1999, making borrowing more expensive and reducing the amount of capital flowing into the market.
- Investor Panic: In April 2000, bad earnings reports from tech leaders like Microsoft and Dell shook investor confidence, leading to a sell-off that spiraled as investors tried to cut losses.
Am I starting to sound familiar? It should be because we're seeing history repeat itself with AI.
What's that Taylor Swift lyric, again? Oh yeah-"I think I've seen this film before, and I didn't like the ending..."
The AI revolution mirrors excitement from the Dot Com boom causing investment in AI startups to soar. However, also like the Dot Com era, there's a wide array of lackluster companies where "AI" is no more than a buzzword used to attract investors.
Take Pets.com, for example, which despite its infamous sock puppet mascot and Super Bowl ads, collapsed due to an unviable business model and exorbitant marketing expenses. It was massively overvalued, had no real revenue stream, and lost investors a boatload of money-$147 million, to be exact.
So, what's the Pets.com of today? Take your pick. There are plenty of AI startups where AI is nothing more than a "feature." A tool, a button, a plug-in-one-trick ponies that seem sexy and future-forward but can easily be copied by a bigger company.
Consider SoundHound AI (SOUN), an "AI" company that provides end-to-end voice AI solutions for businesses looking to automate customer phone calls. It's a fantastic application of AI technology, but is it proprietary? No way. Google could recreate the same thing tomorrow if they wanted. They probably already have a better version in the pipeline.
Stocks like SoundHound are the sock puppets of the AI world-they're features, not companies, and they're leveraging AI to attract investors, not to drive real innovation or growth.
My message to investors is simple: investing in a company only because it's related to AI is like investing in a company because it has ".com" in its name. And the same mistakes that led to the Dot Com crash - overvaluation, lack of profitability, and panic - are already emerging in the AI market.
As we navigate the AI boom, several key lessons from the Dot Com era can guide investors:
- Seek Profitability: Avoid companies with no clear path to profitability, no matter how innovative their application of AI appears. More than a compelling concept is needed; a viable business model is crucial.
- Question Valuations: Be cautious of companies with over-inflated valuations not backed by strong financials or proprietary technology. High valuations should be justified by a solid revenue model and not just the AI hype.
- Understand the Technology: Differentiate between AI hype and genuine innovation. It's essential to understand the technology behind your investment.
Conducting due diligence before investing is more crucial than ever. Don't be swayed by buzzwords and grand visions without substantial backing.
AI has the potential to revolutionize many aspects of our lives, and there will be companies that will make significant strides in this area. But remember, not all that glitters is gold. As we step into the future, let's remember the lessons from our past.
As we saw during the Dot Com era, the potential for a boom also brings the potential for a bust. Let's ensure that this time around, we make sound investment decisions grounded in solid business fundamentals rather than succumbing to AI-fueled market euphoria. Because, as we learned from the Dot Com boom and bust, it's not just about the rush but the lasting value.
Chief Digital Asset Strategist, American Institute for Crypto Investors