Rob Arnott is amazed at what AI chatbots can produce. The Research Affiliates founder recently had ChatGPT summarize one of his papers with “brilliant” results.
“If I was asked to write an 800-word synopsis of the paper, I guarantee you I couldn’t have done that well,” he told Business Insider on Tuesday.
But that doesn’t mean Arnott is bullish on the technology as an investing thesis. For the most part, he thinks future upside is already priced into AI stocks, which makes him less than optimistic about forward returns.
Two things in particular make him wary that some of the most prominent AI stocks can live up to the hype. The first is growing competition.
“Nvidia creates the chips that make AI possible. There are other chip makers. Are they going to sit on their hands and let Nvidia keep a 50% profit margin on the most lucrative part of the AI revolution?” Arnott said.
Second, there’s an unclear path to monetization for consumers of the technology, he said.
“You have to have happy customers, and AI’s customers have yet to figure out how to monetize AI,” he said. “It’ll happen, but they’re still trying to figure it out. So you see hundreds of billions spent on AI technology. The capex is huge, but the reward on that capex has been largely missing.”
With the largest companies in the market focused on AI, stocks have become historically expensive, Arnott said. The total US stock market capitalization relative to GDP — also known as the Warren Buffett indicator — is at an all-time high.
The Shiller cyclically-adjusted price-to-earnings ratio is at its third-highest level in history at around 38.
“I think there’s a lot of froth, I think there’s a lot of concentration,” Arnott said. “Yeah, I’m concerned.”
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He added that he wouldn’t want to be all-in on the S&P 500 and that there are better deals in other parts of the stock market.
The two best deals that he sees right now are small-cap value stocks and emerging market value stocks.
“People have called me a perma bear. I just named two segments of the equity market that are high conviction,” Arnott quipped. “I’m not a perma bear when things are cheap.”
He continued: “When you have a choice between spending, let’s call it 30 times trailing 12-month earnings for the Mag 7, versus buying small-cap value at a Shiller PE ratio of 12, I’m going to go for the Shiller PE ratio of 12.”