AI is going from red hot to white hot. Is that hot enough to burn investors?
Pitchbook notes that venture capital investment in generative AI like ChatGPT is up 425% since 2020, from $500 million to more than $2.1 billion.
The global VC industry is on track to have ¼ of its roughly $350 billion in total assets plunked into AI.
Roughly 40% of companies are either using AI or exploring using AI.
A Crunchbase query shows that the world has 27,505 AI companies, even if not all are pure-play.
ChatGPT is already the fastest-growing app of all time, surpassing 100,000,000 users in two months.
Whether you’re a private market or a public market investor, artificial intelligence seems like an obvious good investment (and perhaps a good investor: the AI Powered ETF (AEIQ) which uses AI to choose its investments, doubled the S&P 500’s returns in January).
But is it really?
Is biotech overvalued?
Biotech gives us clues. Like AI, biotech has a tremendous long-term bull case: The world’s population is getting older and wealthier, and spending a greater share of that wealth on healthcare technology – which, incidentally, keeps getting better. And better healthcare is like indoor plumbing: once you have it, you’re not giving it up.
Since its 2006 inception, the S&P Biotech Index has roughly tripled the S&P 500’s return.
Biotech represents a breakthrough, or string of breakthroughs, for humanity. That’s the good side of the megatrend coin, and the one that gets disproportionate focus from investors.
The darker side is that economics is a recursive social science, meaning that a great trend – in the sense of adding value to the world – can become a lousy investment in aggregate if too many people jump on. Most companies that participate in megatrends end up failing, and most investors do just so-so.
More excitement. Lower standards. Crappier projects. Dumber money.
Is AI as overvalued as biotech?
For instance, biotech turned hot in 2021 thanks to a cocktail of low interest rates (which inflate the present values of cash flows expected far into the future), a giddy “everything bubble” market and, arguably, a COVID-savior halo.
With enough demand, supply will appear – and keep appearing: Per IBISWorld, the number of biotechs has grown at 7% per year since 2018, yet the industry’s market size has grown at 2.6% per year.
This is despite the fact that oversupply is particularly dumb in biotech because of a logistical regulatory “ceiling” of sorts: As my friend, biotech analyst Leon Tang, is fond of pointing out, more than 3,000 biotechs are hoping theirs will be one of roughly 50 new drugs approved by the US Food and Drug Administration each year.
This is slightly less pathetic than the 1-in-60 chance it appears to be, because not every biotech company is vying for an approval every year. But it’s still pathetic that the market wasn’t paying attention to these odds.
If 3,000 people show up to an event that seats 50 (or even several hundred), most will be left standing outside.
AI bubble: seems inevitable
Fundamentals can get (temporarily) bulldozed by the greater fool effect. It’s silly, but let’s not hate it, because the greater fool’s alter ego – irrational avoidance – creates underpricings.
Fortunately, in the long haul, prices of things revert to the value those things add to the economy.
They should. Markets that don’t revert well to economic fundamentals (and instead remain permanently “drunk” with speculation, insider trading, sudden or arbitrary policy changes, etc.) fail at adding value to their societies – which, from a society’s perspective, is supposed to be the benefit of markets.
So, from a market rationality perspective, biotech’s bubble-ish rise is bad, and its reversion is good, even if the me-too investors didn’t feel that way.
More excitement. Lower standards. Crappier projects. Dumber money.
Investors in the dot.com bubble can relate. Yes, some eventual big winners emerged from the tech bubble’s ashes (Amazon AMZN AMZN at one point declined 95% before later rising 58,000%). But in an aggregate sense, the dot.com bubble was just a big version of the biotech bubble: one of the greatest investing frenzies the world has ever seen – yet just about a wash for investors.
It was likely worse than a wash for individual investors. Academic evidence from Brad Barber and Terrance Odean shows that individual investors tend to buy at the top, and Dalbar Research found that individual investors tend to underperform a market index (by buying at the top).
Can I still make money with AI?
The counterargument – whether it’s AI, biotech, tech, or tulips – goes something like this: Maybe hot trends and their resultant bubbles aren’t great for investors in aggregate, but new industries tend to be winner-take-all-ish – a few winners and scores of losers – so I’ll just identify the ultimate winners and buy them.
This can work. And if it does work, it will make you extremely rich. There’s a “but” and there’s a “but” to the “but.”
You can guess the first “but:” the odds are against you.
- Few things changed the world – and the US in particular – as much as the automobile. But more than 3,000 US car makers have come and gone. Sure, some losers were bought by winners, but on balance, if you bought any particular participant, you likely lost money.
- Many people know the story of the American Gold Rush of the mid-1800s: the average California miner made $10-15 per day (probably a generous figure if we consider everyone who tried). The real money was in selling supplies to the people attempting to strike it rich*.
- Although the extent of the Dutch Tulip Mania of the 1600s is doubted by some academics, whoever paid the price of a mansion for a one bulb probably regretted it.
*One could argue that this is the cause of bubbles in the first place, or at least an exacerbator: Instead of picks and shovels, modern enablers are selling the aspiring (if indiscriminate) investors inferior, overpriced versions of the “winners” they hope to buy.
Don’t let me be a wet blanket. If you are truly skilled at identifying the future winners, by all means you should do this. It’s an enormous relative advantage (for instance, there’s evidence that only about 10% of individual investors are actually good stockpickers).
What will AI’s dud-to-winner ratio be?
If you’re not sure but want to play anyway – and this is the “but” to this “but” – we need to talk about histograms.
If you’ve bought a pack of Pokemon cards (or baseball or football cards – or run a VC fund), you understand that most cards in the pack are going to be duds. In fact, many packs are all duds or near-duds. Therefore, anyone aspiring to invest by buying Pokemon packs – probably a dumb thing to do, but this is theoretical – would need to consider two histogram-y questions:
- How many packs will I have to buy before getting one or more winners?
- Will the aggregate winning-ness of my winners offset the aggregate dud-ness of my duds?… i.e., will my winners pay for my losers?
It’s a bit unfair to equate Pokemon card pack investing to VC investing, because randomly buying Pokemon packs requires no skill*, whereas VCs at least try to apply skill to separate wheat from chaff.
*Index investing, by contrast, is a bit closer to Pokemon pack investing, although most index investing isn’t an attempt to net runaway winners per se.
I’m generally skeptical of VC returns data – shop around and you’ll see “averages” ranging from stock market-ish returns to 57% per year – but VC is like the Pokemon pack effect on steroids: Correlation Ventures found that 65% of VC investments lose money, and that just 4% return 10x or more. (And 0.4% return 50x or more.) In fact, Institutional Investor magazine pointed out that a VC fund would need to hold more than 500 investments to capture one of these mega-winners.
The upside of buying all those Pokemon packs? Look at the white rotated square in the middle: It’s higher (although note that these are pre-fee numbers, and VC funds may charge 2-and-20 fees that get negotiated up or down depending on the hotness of both VC and the particular VC fund at the moment). Plus, the dispersion of returns is a lot tighter than I’d have expected, too.
How to win the AI war
- A gold rush where the real money was made on people showing up for the gold rush.
- A tech bubble where values were propped up by people showing up for the tech bubble.
- A biotech bubble that happened because people put more money into biotech stocks, and not because biotech added more value to the world.
- A planet that got motorized – while most of the companies trying to help (and their investors) failed.
Still, my intention isn’t as negative as may seem. I’m really trying to establish that:
- Investors often assume that a hot new thing that moves humanity forward will automatically be a great investment, but so many investors assume this that the hot new thing may end up a disappointing investment in aggregate.
- Mega-winners from megatrends indeed create fortunes for a few people and a few investors, but mega-winners are usually surrounded by hundreds, or thousands, of also-rans.
- It’s possible to diversify by investing in a fund, but there’s a high chance the fund’s returns are also watered down by the also-rans.
- As the market realizes that it owns a lot of also-rans instead of actual mega-winners, prices come down.
Everything I’m saying is a sweeping generalization. Almost recklessly vague. Funds can do very well by investing in hot things. So can individual investors. It happens frequently. And if you invest in AI, my wish is that it happens for you.
My goal is not to dissuade you from investing in AI. AI will change the world. Precedence Research predicts its market size will grow from $120 billion now to $1.6 billion by 2030. AI will birth AI millionaires and AI billionaires.
But if history is a guide, it will leave a lot of dead companies and burned investors in its path.
Bonds See 2023 Recession, Stocks Aren’t So Sure
The yield curve is one of the most robust recession predictors and has signaled a recession may be coming since mid 2022. In contrast, U.S. stocks as measured by the S&P 500 are up materially from the lows of last October and only just below year-to-date highs, seemingly rejecting recession fears. Yet, fixed income markets see the Fed potentially cutting rates by the summer, perhaps reacting to a U.S. recession.
The Evidence From The Bond Markets
The recessionary evidence, at least from fixed income markets, is mounting. The 10 yield Treasury yield has been below the 2 year yield consistently since last July. That is is called an inverted yield curve and has signaled a recession fairly reliably when compared to other leading indicators.
Building on that, fixed income markets see almost a nine in ten chance that the Federal Reserve cuts rates by September of this year. That’s something the Fed has repeatedly said they won’t do on their current forecasts. Yet, a recession could cause it to happen.
The Stock Market
In contrast, the stock market shows some optimism. The S&P 500 is up 7% year-to-date as the market has shrugged off fears of contagion from recent banking issues. In particular, tech stocks have rallied.
In contrast, more defensive sectors such as healthcare, utilities and consumer goods have lagged in 2023. This suggests that the stock market is taking more of a ‘risk on’ position and is perhaps less worried about the economy.
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That said the stock market is a leading indicator of the business cycle, it may be that stocks see a recession, but are now looking past it to growth ahead and are factoring in the lower discount rates that a recession might bring as interest rates decline. Also, the U.S. stock market is relatively global, so the fate of the U.S. economy is a key factor in driving profits, but not the only one.
Monitoring unemployment data will be key. Though the yield curve is a good long-term forecaster of recessions it is less precise in signaling when a recession starts. Unemployment rates can offer more accurate recession timing. Unemployment edged up in February, suggesting a recession may be near, but we’ve also seen monthly noise unemployment. Two similar monthly unemployment spikes during 2022 both proved false alarms.
However, if we see a sustained move up in unemployment from the low levels of 2022 that may be a relatively clear sign that a recession is here. Economist Claudia Sahm estimates that a sustained 0.5% increase in unemployment rate from 12-month lows is sufficient to trigger a recession. Unemployment rose 0.2% from January to February 2023, so maybe we’re on the way there. Of course, the jobs market performed better than expected in 2022 and it could do so again. Still, fixed income markets do suggest a 2023 recession is coming. Stock markets don’t necessarily share that view.
Which States Have The Highest And Lowest Life Expectancies?
There’s a wide variance of life expectancies among the 50 states in the U.S., according to a recent report prepared by Assurance, an insurance technology platform that helps consumers with decisions related to insurance and financial well-being.
Figure 1 below shows the 10 states with the highest life expectancy, starting with Hawaii, the state with the highest life expectancy.
Figure 2 below shows the 10 states with the lowest life expectancy, starting with Mississippi, the state with the lowest life expectancy.
Assurance scoured life expectancy data prepared in January 2023 by the U.S. Centers for Disease Control and Prevention (CDC). With this data, Assurance created several easy-to-understand graphics that offer information about life expectancies.
Life expectancies are a basic measure of well-being
As measured by the CDC, life expectancies are a basic measurement of well-being in a broad population and not a prediction of how long an individual might live. The CDC measures the expected lifespan for a person born in the year of measurement. This measurement is calculated based on the assumption that the individual will live and die according to the rates of death that are prevalent in the measurement year for each age. There’s no assumed improvement or backsliding in the assumed mortality rates in future years for each age in the life expectancy calculation.
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By contrast, an estimated lifespan for an individual would consider their current age, their gender, and some basic lifestyle information. It might also attempt to project future improvements or backsliding in mortality rates based on key factors.
Significant influences on life expectancy calculations
Leading causes of death in the U.S. are heart disease, cancer, and accidents in that order. These immediate causes are significantly influenced by factors in the population such as poverty rates, educational attainment, rates of obesity and smoking, access to healthcare, prevalence of violent crime, and the support people receive from federal, state, and local governments. All these factors can vary widely among different states, which can be a key reason why life expectancies vary by state.
When you think about it, all these factors also have the potential to influence a person’s quality of life. The measured life expectancy rate rolls up all these factors into one objective measurement of well-being that’s based on population data.
In addition to the factors listed above, mortality rates increased and life expectancies decreased in the past few years due to the Covid-19 pandemic. A recent article titled “Live Free And Die” summarized recent research results that show that life expectancies in most countries around the world rebounded after the Covid-19 pandemic but that they continued to decline in the United States. Many of the reasons cited in the article for the continued decline in U.S. life expectancies are the same or similar to the factors listed above.
Why should retirees care about the life expectancies reported here if these measures don’t predict your own lifespan? Life expectancy calculations indicate the general well-being of the entire population in your area. While the living conditions in your area can influence your own lifespan and quality of life, retirees should focus on their remaining life expectancy given their age. They should also consider how the factors listed above that influence life expectancies in the population might apply to them.
You can obtain customized estimates of your remaining life expectancy at the Actuaries Longevity Illustrator. Part of your planning for retirement is understanding how long you an an individual might live, instead of relying on generalized information about larger populations you see in the media.
IRS Dirty Dozen Campaign Warns Taxpayers To Avoid Offer In Compromise ‘Mills’
Owing taxes can be stressful. Unfortunately, the actions of some companies can make it worse. As part of its “Dirty Dozen” campaign, the IRS has renewed a warning about so-called Offer in Compromise “mills” that often mislead taxpayers into believing they can settle a tax debt for pennies on the dollar—while the companies collective excessive fees.
The “Dirty Dozen” is an annual list of common scams taxpayers may encounter. Many of these schemes peak during tax filing season as people prepare their returns or hire someone to help with their taxes. The schemes put taxpayers and tax professionals at risk of losing money, personal information, data, and more.
Tax Debt Resolution Schemes
“Too often, we see some unscrupulous promoters mislead taxpayers into thinking they can magically get rid of a tax debt,” said IRS Commissioner Danny Werfel.
“This is a legitimate IRS program, but there are specific requirements for people to qualify. People desperate for help can make a costly mistake if they clearly don’t qualify for the program. Before using an aggressive promoter, we encourage people to review readily available IRS resources to help resolve a tax debt on their own without facing hefty fees.”
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Offers In Compromise
Legitimate is a key word. Offers in Compromise are an important program to help people who can’t pay to settle their federal tax debts. But, as the IRS notes, these “mills” can aggressively promote Offers in Compromise—OIC—in misleading ways to people who don’t meet the qualifications, frequently costing taxpayers thousands of dollars.
An OIC allows you to resolve your tax obligations for less than the total amount you owe. You generally submit an OIC because you don’t believe you owe the tax, you can’t pay the tax, or exceptional circumstances exist.
Because of the nature of the OIC—and the dollars involved—the process can be time-consuming. It can also be confusing for taxpayers who may not have a complete grasp on their finances.
First, you must complete a detailed application, Form 656, Offer in Compromise. You must also submit Form 433-A, Collection Information Statement for Wage Earners and Self-Employed Individuals, or Form 433-B, Collection Information Statement for Businesses, with supporting documentation (generally, bank and brokerage statements and proof of expenses).
You’ll also need to submit a non-refundable fee of $205 and payment made in good faith. The payment is typically 20% of the offer amount for a lump sum cash offer or the first month’s payment for those made over time. Generally, initial payments will not be returned but will be applied to your tax debt if your offer is not accepted. Payments and fees may be waived if the OIC is submitted based solely on the premise that you do not owe the tax or if your total monthly income falls at or below income levels based on the Department of Health and Human Services (DHSS) poverty guidelines.
The IRS will examine your application and decide whether to accept it based on many things, including the total amount due and the time remaining to collect under the statute of limitations. The IRS will also review your income—including future earnings and accounts receivables—and your reasonable expenses, as determined by their formula. The IRS will also consider the amount of equity you have in assets that you own—this would include real property, personal property (like automobiles), and bank accounts.
Before your offer can be considered, you must be compliant. That means you must have filed all your tax returns and paid off any liabilities not subject to the OIC. After you submit your offer, you must continue to timely file your tax returns, and pay all required tax, including estimated tax payments. If you don’t, the IRS will return your offer.
Additionally, you cannot currently be in an open bankruptcy proceeding, and you must resolve any open audit or outstanding innocent spouse claim issues before you submit an offer.
You can probably tell—it’s a lot to consider. You may want representation. A tax professional can help marshal you through the process and offer practical guidance, while communicating what fees could look like.
By contrast, according to the IRS, an OIC “mill” will usually make outlandish claims, frequently in radio and TV ads, about how they can settle a person’s tax debt for cheap. Also telling: the fees tend to be significant in exchange for very little work.
Those mills also knowingly advise indebted taxpayers to file an OIC application even though the promoters know the person will not qualify, costing taxpayers money and time. You can check your eligibility for free using the IRS’s Offer in Compromise Pre-Qualifier tool.
“Pennies On A Dollar”
What about those promises that taxpayers can routinely settle for pennies on a dollar? Not true. Generally, the IRS will not accept an offer if they believe you can pay your tax debt in full through an installment agreement or equity in assets, including your home. That’s why the IRS tends to reject a majority of OICs that are submitted. The acceptance rate is less than 1 in 3, according to the 2021 Data Book.
The IRS will generally approve an OIC when the amount offered represents the best opportunity for the IRS to collect the debt. It’s true that there’s a formula that the IRS uses to figure out how much they think they can collect from you. But there is some wiggle room to account for special circumstances, including a loss of income or a medical condition. It’s worth noting those are the exceptions, not the rule.
While submitting an OIC may keep the IRS from calling you, it doesn’t stop all collections activities—don’t believe companies that suggest that submitting an OIC will make your tax debt disappear. Penalties and interest will continue to accrue on your outstanding tax liability. Additionally, the IRS may keep your tax refund, including interest, through the date the IRS accepts your OIC.
You may also be liened. In most cases, the IRS will file a Notice of Federal Tax Lien to protect their interests, and the lien will generally stay in place until your tax obligation is satisfied.
An OIC is a serious effort to resolve tax debt and shouldn’t be taken lightly. Be skeptical—if it sounds too good to be true, it likely is. If you’re considering an OIC, hire a competent tax professional who understands the rules and is willing to level with you about your chances of being successful—including other options. Don’t fall into a trap that can make your situation worse.
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