As the artificial-intelligence boom has driven the market past bad news and towards record highs, investors are wrestling with the question, “Is this a bubble?”

I’ve been tracking the stock market for nearly 40 years, and one thing I can tell you is that market bubbles don’t truly become evident until they pop; by that time, it’s too late to avoid the resulting market freefall.

Investors who are old enough to remember the Dot-com bubble, like me, can’t help but be haunted by its memory today.

The Dot-com bubble was pumped by the adoption and acceptance of the Internet in the 1990s, when seemingly any company with a website or dot-com extension in its name was ready for take-off.

Between 1995 and March 2000, the Nasdaq Composite Index was up 600%.

When the market peaked on March 10, 2000, however, the Nasdaq Composite dropped by nearly 80% by October 2002; many investors lost all their bubble gains.

Because tech stocks drove the Internet bubble, comparisons to today’s artificial-intelligence-driven times are inevitable.

The times are not the same, however. The Internet bubble was driven by inflated valuations on companies with no earnings. Burgeoning A.I. firms already have profits, effectively placing a floor on just how far they’d fall if conditions change dramatically.

Investors are debating whether or not the stock market has reached bubble territory.

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AI isn’t dot-com bubble (yet), despite similarities

Moreover, many experts argue that artificial intelligence technology is more revolutionary than prior tech bubbles, driving more change for a longer period than the microprocessor of the 1970s or the Internet of the 1990s.

Jeffrey Hirsch, president of Hirsch Holdings and the editor of Stock Trader’s Almanac, has been calling for “an A.I. super boom” since 2010, when he forecast that the Dow Jones Industrial Average would hit 38,820 by 2025.

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Having made that number ahead of schedule, Hirsch recalibrated his forecast to Dow 62,000 over the next few years, a level requiring just an 8.5% annualized average gain, which the benchmark has achieved since 1950.

“I think A.I. is impacting everyone individually and the world and market and economies collectively, and it’s just kind of beginning to me,” Hirsch said in an interview on the Dec. 8 edition of “Money Life with Chuck Jaffe.” “It feels a lot like the early/mid-90s when we were getting the Internet really cranking up. … It’s just beginning to permeate everyone’s lives.”

That kind of sentiment deflects concerns of a bubble.

Analyst disagrees, ‘perfect storm’ brewing

The market, however, determines if that’s reality or just wishful thinking, and a portfolio manager at a firm with a long track record of calling bear markets, corrections and crashes says conditions now are building a perfect storm of trouble.

Zach Jonson is the chief investment officer at Stack Financial Management, a Whitefish, Mont.-based money manager with roughly $2 billion in assets under management, operating with a “Safety First” approach.

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Stack Financial is a sister company to InvesTech Research, both run by James Stack; InvesTech has a track record of more than 45 years, which includes warning about the 1987 market crash in the days before it occurred, calling the end of the Internet bubble just three months before the market peaked, and also calling for several big market runs as they were just blasting off.

In an interview on “Money Life with Chuck Jaffe”, Jonson said the bubble is already here and that the market is facing “a trifecta of bear-market risks.”

The three bear market risks are:

  • An overvalued stock market
  • A market that’s too concentrated in a few securities or sectors
  • An economy held down by a housing market that’s struggling with affordability issues.

Jonson said the stock market level of overvaluation “has occurred only two other times in history and that’s 1929 and 1999.”

The market also is highly concentrated, Jonson said in a Money Life interview that aired on Nov. 21, with “almost 40% [of the S&P 500’s valuation href=”https://www.thestreet.com/dictionary/s/s-p-500″] in information technology, but if you actually look at the companies that are so tech heavy, so A.I. related, you can push that upwards of 50% of the S&P 500 very focused on one segment that is receiving all the headlines. … That level of concentration is extremely dangerous if that thesis or that idea starts to unwind a little bit.”

The housing segment is a crucial macroeconomic keystone. “Historically,” Jonson said, “when you look at unaffordable housing to this level, it usually is not pretty the way it comes down. And that can really affect the overall market. It can affect the economy.”

The trifecta, Jonson explained, “leads to a multifaceted bubble that makes us really concerned about how this will unwind,” but that hasn’t put him on the sidelines in cash.

“We don’t want to be perma-bears where you sit here and just put everything underneath the mattress,” he said, “and instead, we just really do think there’s an active risk-management approach to getting through this environment.”

What investors can do to protect against risk

Bubbles are tough to call and to time. “You can sit there until you’re blue in the face and say that this is a bubble and then it just keeps running and it keeps running and it keeps running and you get steamrolled,” he said.

On the other hand, waiting too long is also a problem. “We think with the valuation risk and with the excessive hype that you could definitely see something that’s one of the great bear markets of our lifetime,” he said.

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As a result, he’s avoiding “the riskiest segments of the market,” staying “heavily underweight” artificial-intelligence and technology names, and looking instead to the “left-behind value segments of the market that are trading cheap,” noting that there are some health-care stocks carrying single-digit price/earnings ratios and consumer-staples companies hurt by inflation but poised to get their pricing power back if inflation falls.

Jonson also likes emerging markets – though he cautions that story may take a while to play out – and gold.

“One of the challenging things with this cycle is the ‘Buy the dip’ mentality is so pervasive, probably the most pervasive I’ve ever seen in my career,” Jonson said. “So there’s no doubt in my mind that we’re going to have steps down that rebound with very, very quick V-shaped rebounds.

“The true test of when this final unwind is happening is when you actually get stocks going down 10, 15, 20 percent … and then we get another 10 to 15 percent after that,” Jonson added. “That buy-the-dip mentality is going to be tough to break, but when that does happen, the duration of this could be a 12- to 18-month unwinding process. … It’s going to take numerous months to get through.”

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