Small investors involved in index funds might find themselves in a precarious position if the anticipated AI investment surge, starting next week with SpaceX’s massive IPO, eventually falters.
This caution comes from experienced investors like Lawrence McDonald, a former Wall Street trader and founder of the Bear Trap Report. He points to the typical behavior of markets when early technologies emerge.
McDonald has examined the high valuations expected for upcoming IPOs of AI companies, including SpaceX, Anthropic, and OpenAI, arguing these figures aren’t sustainable.
All these companies aim to go public this year, kicking things off with SpaceX, which is set to announce its pricing next Thursday, potentially starting trading as soon as Friday. The excitement on Wall Street is palpable, pushing these stocks into conversations as the next big tech successes like Apple or Google. However, McDonald recalls witnessing several market crashes that share a common trend: inflated valuations at the start, often with insiders cashing out before the bubble bursts.
Retail investors often face losses when popular stocks begin to decline.
McDonald believes the current AI hype could lead to an even bigger fallout than past market downturns. The sheer scale of enthusiasm surrounding AI, coupled with an increasing number of small investors using tech-focused passive and index investing, means that many who aren’t keen on tech could still be caught up in the impending correction.
He notes that index managers exacerbate the issue by relaxing entry requirements for new companies. Historically, firms were expected to be profitable for a year before they could be included in the index. Yet, SpaceX, OpenAI, and Anthropic have yet to turn a profit. Opinions vary on when, or if, this will change.
Meanwhile, S&P is contemplating rules that would facilitate quicker entry into the index. Both Nasdaq and Russell have already implemented similar fast-track protocols.
McDonald highlights that, unlike when Facebook went public in 2012 with a valuation of $100 billion after turning a profit, SpaceX’s valuation stands at a staggering $2 trillion, despite not yet making money. This situation heavily relies on optimistic projections about its future, such as the potential for space-based data centers.
Officials from S&P state that methodological adjustments to index maintenance aim to ensure it meets its intended goals, acknowledging how different the public market landscape is today compared to, say, a decade ago. A Nasdaq spokesperson echoed this, indicating that the updates reflect the evolving dynamics of how companies navigate their public market journeys.
Elon Musk has generally been favorable to his investors with Tesla. SpaceX appears to be in a solid position, marrying rocket technology with Starlink’s global satellite services, all enhanced by AI capabilities. This sentiment also applies to AI leaders like OpenAI and Anthropic, which are spearheaded by notable figures in the field.
The advent of this technology is driving a productivity surge as businesses adopt it for more efficient operations, which might explain the stock market’s recent upward trends. The resilience of the U.S. economy amid various challenges seems tied to the genuine advancement of AI, rather than a mere echo of past tech bubbles.
While costs associated with AI—like components and data center construction—are on the rise, supporting inflated valuations, seasoned analysts suggest that history shows such enthusiasm often leads to price drops as competition ramps up in tech sectors.
In short, even if SpaceX’s valuation exceeds $1.8 trillion at its IPO, a market correction is likely on the horizon. This leaves passive investors in index funds vulnerable while insiders typically retain their stocks.
The Nasdaq, for example, dipped to about 1,100 in 2002 following the dot-com bubble burst and took a decade to recover to current levels above 27,000 amid ongoing rallies.
So, buyer beware.
