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Putting All Your Eggs in One Basket: A Cautionary Tale

Putting All Your Eggs in One Basket: A Cautionary Tale

May 26, 2024

"Hitch your wagon to a star," wrote Ralph Waldo Emerson.1 Many people take this famous metaphor to mean simply "aim high." But Emerson possibly had more in mind. Your wagon (your life prospects) needs something to pull it. He was suggesting that rather than settling for the usual plodding horse, why not hitch it to something high flying, like a star?

Many investors seem to have taken this latter meaning of Emerson's advice to heart. Rather than being content to have their portfolios pulled along by plodding index funds, they're on the lookout for the next star. If they can pick the right stock, it could multiply their earnings overnight.

Lately, the high flier of choice has been chip maker Nvidia. In late February, when the S&P had gained 1.7% for the week (a remarkable gain for such a broad index), Nvidia gained 16.4% in a single day, pushing the company's market capitalization up to $2 trillion.2

What's been driving this dramatic growth in Nvidia's stock price? The anticipated revolution that will be brought about by Artificial Intelligence (AI). Forecasters and opinion leaders are predicting that AI will be able to do many of the kinds of jobs now being performed by humans. This technology will supposedly upend the standard business model, much like the automobile took over transportation from the horse and buggy.

And, presently, Nvidia is making the lion's share of computer chips that can handle the intensive processing required to run the advanced AI engines around the world.

If you've ever spent time querying ChatGPT or any of the other popular Large Language Model (LLM) chatbots, then you have to be impressed with the technology's human-like responses. Further, AI has the ability to compose whole pages of intelligent sounding text in just a few seconds.

So far, AI has made it easier for college freshmen to crank out those papers on William Faulkner. But LLMs have the bad habit of generating erroneous information and making it sound entirely plausible. So, could an unattended chatbot be trusted to replace a human? Not in cases where an error would be costly.

Financial writer Peter Navarro points out that this entire scenario is eerily similar to something he saw just over twenty years ago. In the late 1990s the most-listened-to experts were predicting that the new worldwide web would be upending the standard model for business. For example, websites would be replacing most brick-and-mortar stores. The companies then responsible for much of the Internet's back end—Cisco, Intel, and Oracle—saw their valuations soar. 

But then came the reckoning. It turned out that simply having a sophisticated website did not guarantee profitability. Many high profile dot com companies collapsed. And the valuations of Cisco, Intel, and Oracle fell by as much as 80%.

Today we know that the Internet can be an important component of a company's sales channel. But it hasn't fundamentally changed the rules of business. The same could certainly prove true for AI. And if it did, then individual stocks like Nvidia would be uniquely positioned to see any irrational optimism embedded in today's valuations deducted from their value, whether via decline or lack of future price growth.

To paraphrase Mark Twain, we know that history doesn't repeat itself, but it does often rhyme. No one can be sure what the future holds in general, and certainly not for any specific stock. Just as there are differences between, say, Cisco and Nvidia's technologies and stories that may cause the ending to differ, consider also that past performance is by no means a guarantee or even predictor of future results. FOMO is not a successful decision-making technique, and businesses valued at levels that reflect perfect or ideal future conditions/assumptions raise a higher bar to clear for future success.

New technology will bring added productivity and profitability. And the prudent investor will look to benefit from these advances. However, he or she will also position themselves to weather the declines of individual stocks. This is done by holding a portfolio consisting of research-backed diversification methods, following a tailor-made financial plan, and enlisting the help of trusted advisors like our team.

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