Analyst Labels AI As 'Infant Bubble,' Warns Federal Action Could Burst It: 3 Investor Lessons From Dot-Com Collapse

Bank of America's chief investment strategist Michael Hartnett called the AI a "baby bubble" with inflationary effects for the economy in his most recent 'The Flow Show' report. 

The analyst said that the first phase of the AI-stocks' surge can be compared to other market bubbles in recent decades, such as Cathie Wood's ARKK Innovation ETF ARKK after 2019, FAANGs after 2016, dot-com stocks in the 2000s and Asian stocks in the 1990s.

"Bubbles in right things, such as internet, and wrong things, such as housing, always started by easy money, always ended by rate hikes," Hartnett said. 

Among the 2023 leaders in AI-related investments are Microsoft Corp. MSFT, NVIDIA Corp. NVDA, Alphabet Inc. GOOG GOOGL, Advanced Micro Devices, Inc. AMD, and Meta Platforms, Inc. META.

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According to Hartnett, AI would be inflationary for the economy since politicians today would never "allow AI to cause widespread unemployment, even if just temporary." The expert advised investors to "expect regulation and/or another push for universal basic income (UBI) policies," with the potential of higher taxes and "bigger & bigger government budget deficits." 

The expert then offered three lessons that investors should keep in mind by examining the origins and consequences of previous bubbles.

Lesson 1: Cheap Money Created Internet Bubble

The Fed responded to the Asian and Russian financial crises of the 1990s by lowering interest rates, despite the fact that the economy did not require it. This merely fueled the Internet dot-com bubble, with the Nasdaq jumping from 2000 to 5000 between October 1998 and March 2000. "We don't advise chasing the bubble in 2023," Hartnett said, noting that more than 200 basis points of Fed rate cuts are already priced in until the 2024 elections. 

Lesson 2: A Bubble Occurs When Asset Prices Disregard Rising Costs of Capital

As the Nasdaq reached 5000 in 1999, 30-year Treasury yields rose to over 6.5% and strong macro pushed the Fed to tighten monetary policy again in 1999. The dot-com bubble burst nine months later. If the Fed "mistakenly" pauses in 2023 and U.S. bond yields move beyond 4%, we have not seen the last Fed rate hike of the cycle, according to the analyst. 

Lesson 3: Investors Must Barbell "Hubris" With The "Humiliated"

There was only one stock index that outperformed the Nasdaq internet bubble from October 1998 to March 2000, and that was Russia, which had gone bankrupt and massively devalued its currency in 1998, Hartnett highlighted. U.S. Regional bank stocks would be the "best bubble hedge" if the AI bubble rages on in the second half of the year. 

Now read: US Value Stocks Trail Growth Stocks By An Alarming 8% In 2023: Why Is The Value Style Underperforming Again?

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