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Yes – And Here Is How You Know For Sure

This is Porter’s Daily Journal, a free e-letter from Porter & Co. that provides unfiltered insights on markets, the economy, and life to help readers become better investors. It includes weekday editions and two weekend editions… and is free to all subscribers.

Today, Porter turns the Journal over to Erez Kalir, editor of Porter & Co.’s Tech Frontiers.

Erez has degrees from Stanford, Yale, and Oxford, has studied biology, finance, and law, and has worked at McKinsey & Co. and for Julian Robertson at Tiger Management. Porter & Co. has recently expanded the domain of Erez’s investment research to include tech stocks, the blockchain, and science beyond his original focus of biotech.

Six of the 12 open positions in the Tech Frontiers portfolio are up 50% or more since he recommended them. There are three more that doubled before he suggested selling them to take gains. Overall, the open portfolio is up 49% since he launched it in 2024.

In today’s Journal, Erez discusses the extraordinary valuations seen in stocks of companies in the artificial-intelligence (“AI”) sector and explores whether or not there is an AI bubble…

What does it really mean to be in an AI bubble?

In his classic book Manias, Panics, And Crashes: A History Of Financial Crises, Charles P. Kindleberger defines a financial bubble as “an upward movement in prices… that feeds upon itself; rising prices attract ever-increasing numbers of buyers seeking to profit from the price rise, until the process becomes unsustainable.” At the heart of Kindleberger’s definition are two crucial elements that define any bubble – and that can be applied to an artificial-intelligence (“AI”) bubble:

1. Asset prices that detach from fundamentals, driven by

2. Excessive optimism and herd behavior

Let’s begin with the relationship between asset prices and fundamentals. Historically, three measures have proven to be the most powerfully predictive indicators relating current stock valuations to future returns:

• The 10-year cyclically adjusted price-to-earnings (“CAPE”) ratio

• The stock market’s overall price-to-book ratio, sometimes called “Tobin’s Q”

• The ratio of the total market capitalization of stocks to U.S. GDP, sometimes called “the Buffett indicator”

Today, all three indicators are at historically high levels – in fact, they’re flashing red. The CAPE ratio for U.S. stocks stands at 39.5x, after a minor pullback from a high of 41.2x last November… only the second time in history it has exceeded 40x – the other being in late 1999, on the eve of the dot-com crash. Meanwhile, the stock market’s Tobin’s Q rate is around 2.0, the first time in its 120 recorded history it has had a 2-handle. And at 221%, the ratio of the total market capitalization of stocks to U.S. GDP is also at an all-time high, more than double its historical mean of 90%. In every prior instance that these measures have levitated so far above their means, a violent crash has eventually ensued.