AI: Bubble, Fad or Seismic Shift?
3/3/24 Prospero.Ai Investing (102nd) Edition (Weekend)
Happy March everyone! For newer readers linking our short intro + learning videos.
Prospero continues to have superior performance for the year. We are currently beating the S&P 500 by 283% with a win rate of 75% against that benchmark.
Back to the regular livestream times this week tomorrow 3/4 at 11 AM EST and Wednesday 3/6 at 3 PM EST. Simulcast from our X/Twitter page. Also you can listen / watch after we air because we are now on Spotify!
Whether it's social media or the talking heads on your favorite cable news channel, they all seem to be asking the same question. Is A.I a passing fad? Is it a bubble? One of the primary comparisons I hear is to the Dot Com bubble that happened from the late 90’s to its peak on March 10th 2000. Companies like Boo.com, Webvan and other internet based companies, with little revenue and ridiculous forward P/E ratios kept going up and up in an endless sea of green. Euphoria kicked in and everyone and their grandmother became an expert stockbroker….until of course, it all came crashing down. When it comes to the current A.I. boom, there are some similarities. Companies like NVDA and SMCI are growing at incredible rates. But we would argue, that might be where the comparison’s end. At the height of the Dot Com mania, the Nasdaq Composite, had an absurd P/E ratio of 200. Today, the company that is driving the market (NVDA) has a forward P/E of 66. SMCI has a forward P/E of 41! Not cheap, but not fundamentally overpriced either.
We believe that Artificial Intelligence is not a fad or a bubble, but it’s a fundamental shift in the way that everyone does business and lives their everyday lives. We’re seeing businesses allocate money for A.I. when they don’t even really know what they're doing yet. That’s not the result of a fad. That’s a bunch of smart business leaders seeing the seismic potential of a radical new technology. And it’s this paradigm shifting technology that we believe is driving this market higher and higher. As we’ve mentioned in previous newsletters, the current market is in uncharted waters. New record highs and mountain-top resistance levels keep getting taken out. Everyone is speculating about when an overdue correction might come. And last week was a classic example of how Prospero’s indicators helped us stay on top of the volatility and make much-needed adjustments in a rapidly changing market environment. Since this territory is so uncharted, we will continue to see these “micro corrections” in Tech. This is why we are having a great deal of sensitivity to market prices, because we cannot even begin to discuss what reasonable valuations for these AI businesses or AI expansions will be. The market will be figuring it out on an ongoing basis too.
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AI: Bubble, Fad or Seismic Shift? Outline:
Market/Macro Update
QQQ and SPY Net Options Sentiment
Sector Update / Portfolio Strategy
Now the Sector analysis will be roped into our allocation!
Longs
Adds —> Keeps —> Drops
Shorts
Adds —> No Keeps —> Drops
Portfolio Summary
Last week’s Net Options Sentiment levels from the 2/25 letter:
For Tech: QQQ Net Options Sentiment > 40 = Bullish. < 30 = Bearish.
For Non-Tech: SPY Net Options Sentiment > 40 = Bullish. < 30 = Bearish.
QQQ returned 2.02% this week vs .98% for SPY.
If you forced us to pick one word to describe last week's market, we would probably choose “volatile”. The bulls and bears were in an epic tug of war to determine which direction the market would ultimately turn. Here’s why…. Historically speaking, we find ourselves in a relatively unique time to be an investor. To start, the markets have been up 16 of the last 18 weeks. That’s only happened 5 times since 1950. Additionally, February (seasonally speaking) is typically a down month for stocks. As a matter of fact, since 1970, the S&P 500 has gained over 5% in February, a grand total of 7 times. One of those times was this February, where we saw an increase of 5.2%. In 5 of those previous 6 instances, the average S&P (year-end) return was 16.4%. Odds are highly in our favor that we could see a bullish continuation in the months to come. But with all the positive momentum, people are on watch for a pullback. Like many expected, in the middle of last week, our QQQ and SPY Net Options sentiment dipped alarmingly toward bearish territory. But by the end of the week, the bulls pulled out the win. Both sentiment numbers climbed rapidly and stabilized back near the high 40’s. On Friday after the market closed, SMCI went on a 12.4% rip because of its inclusion in the S&P 500. We ended the week as strong as ever. But like many, we didn’t begin the week with a ton of confidence in breaking more records and we were extremely cautious in our approach entering the week. We picked longs from several, conservative sectors like (Energy, Basic Materials and Healthcare). Our one technology pick, Lam Research, was chosen because we thought it was a less volatile, value pick. (For Tech) But as the week progressed, I began to notice that Prospero’s short pressure numbers for the tech sector began to drop. After the inflation data came in, the entire Tech sector began to move and ultimately reversed to the upside. We were able to reverse with it and enter into a more technology heavy portfolio. There’s a good lesson to be learned here. In the market, you have to stay nimble and constantly question any presuppositions or strategies you might hold. Had we ignored our numbers and stuck to our original thesis, our results at the end of the week could have been radically different. We do well because we play defense first and that solid foundation provides stable ground to find our spots to take big shots on offense.
Take a look at the SPY Net Options Sentiment below. You can see the obvious drop in sentiment, but found a steady bottom and began to reverse with a slow uptrend toward the end of the week. As with last week, we will keep our eyes peeled on our sentiment numbers to see if once again we might see a reversal to the downside.
With the above graph, you can get a visual picture of the stunning turnaround in sentiment for our QQQ Net Options Sentiment. One thing to keep in mind this week is when we see a bottoming out, followed by a period of consolidation, that can often be followed by a dramatic move. It’s really important to keep an eye on these levels and react accordingly. Best place to stay up to date with us is always with our trading letter.
For Tech: QQQ Net Options Sentiment > 40 = Bullish < 30= Bearish.
For Non-Tech: SPY Net Options Sentiment > 40 = Bullish < 30 = Bearish.
Sector Analysis / Portfolio Macro Strategy
Take a look at our Sector analysis chart. Technology continues to be unstoppable. The AI boom continues to create a risk-on environment for this sector that’s led the way for the last year. But the question remains, how will the A.I boom expand into different sectors? It’s a question I get everywhere I go. I was in Mexico last week and I talked to a lot of folks who were introduced to Prospero. The number one question I got was “What’s the next sector that’s going to blow up?” It’s honestly very difficult to know. People assume that semiconductors will be the driving force of the A.I. boom. They might, but there are cloud companies with piles of cash that are feverishly working on developing their own chips. Nobody knows who the leaders will ultimately be. As a result we’re taking a step back and placing a bet in a sector that we have high confidence will be effective regardless of where the A.I. winds blow. That sector is Materials; and specifically, precious and rare earth metals. No matter who is making or buying the chips, they have to be made from precious metals. So that is why REMX became an obvious add last week and it is already paying off! REMX tracks an index of global companies that mine, refine, or recycle rare earth and strategic metals. We’re playing the long game, but we feel that ultimately it will pay off. You might ask why we don’t pick a stock here? That is a case of what we teach all the time, knowing your limitations, the amount of time it would take to learn about the exposure to different strategic metals and which companies had the best long term advantages is a long journey we will dive into over time, but for now we’d rather take the diversified bet until we have a stronger view.
On the bearish side, utilities continue to show weakness. As a matter of fact, S&P Utilities Forward P/E’s are at a twenty year low when compared to the overall market. This Sector looks like an enticing short opportunity.
We are feeling a little safer this week with QQQ and SPY Net Options Sentiment leveling off so we will do 6 Bulls and 3 Bears as well as our index Bull REMX.
Long / Bull Adds - Link to Below Picture
Long / Bull Keeps
ETN is a keep, and returned 3.08% vs .98% SPY benchmark. “We’ve been holding for a bit and we think it might be ready to make a bigger Bull move soon.” Is what we said last week, not much of a reason to change that language.
LLY is a keep, and returned 1.63% vs .98% SPY benchmark. This stock is remarkably consistent at the top of our signals above other Healthcare companies.
LRCX is a keep, and returned 5.71% vs .98% SPY benchmark. We think it is the “safest” chip play. As a result we will hold onto it despite AVGO being a little above with the same technicals. (AVGO also reports this week so was a big reason to avoid as well)
META is a keep, and returned 3.77% vs .98% SPY benchmark. Just another boring week at the top of our signals for META. We like “boring” gains ;)
SMCI is a keep, and returned 5.29% vs .98% SPY benchmark. With the big S&P 500 addition announcement no way we’d drop it for being filtered out. The shorts could be in some major pain tomorrow!
TRGP is a keep, and returned 2.38% vs .98% SPY benchmark. This is lower in the screener but we like the upswing in Energy and this is our favorite stock in that Sector.
Long / Bull Drops
EXP is a drop as the technicals flipped in a bad direction. Covered 2/19-3/1, and it finished +3.93% and a Win, beating its SPY benchmark by 1.26%.
Short / Bear Adds - Link to Below Picture
Other than targeting Utilities we took the two highest companies in the screener that had good technical setups for Bears. We didn’t do Real Estate because the Sector had a good close to the week and we’ve been burned one too many times with Real Estate shorts to not keep our distance on this one.
Short / Bear Drops
EQC is a drop because we do not love the Real Estate setup or the fall in the Screener. Covered 2/26 - 3/1 returning +3.44% and a Loss, losing to its SPY benchmark by 2.45%.
Portfolio Allocation
7 Longs: LRCX, TRGP, LLY, ETN, META, SMCI, REMX
3 Shorts: FRHC, SBGI, OGE