Wall Street grows worried about an AI bubble

Key Concepts

• Michael Bur's Short Positions: Hedge fund manager Michael Bur has taken put options on Nvidia and Palantir, betting on their stock price declines.
• Market Exuberance and Valuations: Concerns about excessively high valuations in the tech sector, particularly for AI-related stocks, are a central theme.
• Momentum Trading: The current market is characterized by strong momentum, making it difficult to bet against popular stocks.
• Diversification Strategy: Experts recommend diversifying portfolios beyond concentrated tech holdings.
• Interest Rate Sensitivity: Companies that benefit from falling interest rates are highlighted as potential investment opportunities.
• AI Stock Performance: The discussion revolves around the sustainability of high valuations for AI companies, with a distinction made between infrastructure builders and more speculative bets.
• Palantir's Performance and Valuation: Palantir's strong fundamental results are contrasted with its high valuation and recent stock price pullback.
• Federal Reserve Policy: The potential for interest rate cuts and their impact on the market is a significant factor.
• Alternative Data Sources: The absence of government data necessitates reliance on alternative sources for economic insights.

Michael Bur's New Targets and Market Exuberance

Michael Bur, renowned for his successful short bet against the US housing market in 2008, has recently acquired put options on Nvidia and Palantir. This move, revealed in a 13F filing, indicates his expectation of price declines in these technology giants. This action follows Bur's cryptic social media posts alluding to market exuberance, positioning himself as a "Cassandra" warning of potential downturns.

Max Wasserman, co-founder and senior portfolio manager at Myiar Capital, views Bur's actions as a reasonable response to the current "ridiculous" valuations in the tech sector. He notes that Palantir, for instance, has seen a 170% year-to-date increase, trading at approximately 250 times earnings. Wasserman argues that these tech stocks are being valued for "growth in perpetuity," assuming no future setbacks. However, he cautions against shorting a momentum market, acknowledging the risk involved even with put options, which are less risky than outright shorting.

Investor Strategies Amidst High Valuations

For individual investors, the question arises on how to navigate this market. Wasserman suggests that while not advocating for complete divestment, it's prudent to scale back holdings in large-cap dividend tech stocks. This is due to both the elevated valuations and the desire to avoid over-concentration in a sector that experienced a 20% NASDAQ decline in March and April of the same year. He advises taking some profits and managing downside risk, as the potential for further upside at multiples of 40, 50, or even 200 times earnings seems limited, with a greater perceived downside risk in the near term.

Diversification and Interest Rate Sensitivity

Wasserman emphasizes the importance of diversification, which for Myiar Capital involves a barbell strategy. Their portfolio includes individual dividend growth stocks, with tech representing about 25-27%. They are also diversified across healthcare, consumer staples, and energy sectors. The rationale is that as interest rates decline, companies in these sectors, such as Home Depot and McDonald's, are expected to benefit. These "defensive names" offer growth without the exorbitant multiples seen in tech. Healthcare, in particular, is attractive due to its dividend yields (3-4% on average for pharmaceuticals) and companies like AV and Waste Management are highlighted as strong investments.

Wasserman points out that the current market dynamic sees investors piling into the "AI trade" and its derivatives, selling off non-tech assets. This creates a "great risk-reward outside of AI," but the momentum in AI makes it challenging to profit at current levels.

Catalysts for Momentum Reversal

The discussion explores potential catalysts that could end the current momentum. Wasserman suggests that a simple realization by investors that paying 250 times earnings for a company is unsustainable could trigger a correction. Even multiples like 55 times earnings on good companies are problematic when growth rates are valued in perpetuity. Any "hiccup" in growth projections could lead to significant stock price drops, potentially 20-30% or more, as seen in past NASDAQ corrections (e.g., 34% in 2022).

A significant concern raised is the circular financing surrounding OpenAI. Wasserman explains that companies are funding OpenAI, which then counts that revenue back, creating a potentially unstable loop. If OpenAI's financing faces any disruption, it could trigger a "domino effect" with systemic risk for the broader market.

Palantir: Fundamentals vs. Stock Performance

The conversation then shifts to Palantir, with differing perspectives on its recent stock performance despite strong earnings. While Michael Bur's put options on Palantir are noted, some analysts see the stock's pullback as an opportunity.

Kenny, a market commentator, expresses surprise that Palantir was sold off after "crushing it on every metric" and raising full-year guidance. He dismisses the subsequent concerns about overvaluation and unmet expectations as "noise." Kenny believes the AI story and Palantir's narrative are "very much alive and well" and views pullbacks as opportunities. He highlights Palantir's strong fundamental performance, exceeding expectations and guidance, and praises CEO Alex Karp's enthusiasm.

However, Kenny also acknowledges the market's reaction, noting the divergence between the S&P 500 and its equal-weight counterpart, with the latter showing signs of weakness. He suggests waiting a couple of days to let the news settle before considering an investment in Palantir after such a reaction.

Palantir's Valuation and Retail Investor Base

The discussion highlights Palantir's valuation, with a price-to-earnings ratio of around 213 times forward earnings, which is acknowledged as "not cheap." Despite this, its commercial business grew by 121% year-over-year, and it "blew it out of the water" in every segment. A significant factor is Palantir's strong support from retail investors, who own over 45% of the stock. CEO Alex Karp's engagement with retail investors is also mentioned.

Federal Reserve Policy and Market Volatility

David Royal, Chief Financial and Investment Officer at Thriving, discusses the impact of the Federal Reserve's stance on interest rates. He believes the trend in the market is "generally intact" but notes that the Fed's press conference, where a December rate cut was deemed "far from a foregone conclusion," introduced uncertainty. This, combined with already high valuations, is likely contributing to increased volatility.

Royal suggests that while the market may not require a December cut to move higher, the uncertainty surrounding it is a concern. He anticipates higher rate volatility, which can drive equity volatility and put pressure on high-valuation stocks.

Fed Rate Cut Debate

Royal states he would vote for a rate cut, citing weakening unemployment figures. He references Fed Chair Powell's past comments about unwelcome weakening in the employment market. However, he acknowledges the Fed's concern about inflation remaining above target, with a stalled trend and a slight uptick in goods inflation, keeping PCE stubbornly at 2.9%. He was surprised by Powell's specific inflation forecast of 2.3-2.5% absent tariffs.

AI Valuations and Investment Themes

The conversation returns to AI valuations, with David Royal noting that many AI companies, unlike those in the dot-com bubble, are funding investments from earnings and cash flow, which is a positive. However, he stresses the need for a company-by-company analysis, considering valuation theses, business models, and potential drains on buybacks.

Sector Preferences and Consumer Bifurcation

Royal still favors big-cap tech but leans away from cyclical sectors like consumer discretionary and industrials due to signs of economic weakening. He observes a bifurcation in the consumer market, with the upper-end consumer performing better. He suggests investing in companies serving this demographic and those driven by product innovation rather than macro tailwinds. This is supported by commentary from companies like Clorox (consumers under pressure, value-seeking) and Marriott (luxury hotels outperforming).

Alternative Data and Economic Indicators

The lack of government data due to potential shutdowns leads to reliance on alternative data sources. ADP reports, jobless claims, and the Challenger Gray & Christmas report on future hiring plans are mentioned as key indicators. The significant drop in holiday hiring announcements (115,000 through September, compared to a typical 600,000) and layoffs at major hiring firms like Target and UPS are concerning signs of potential economic slowing. This data reinforces Royal's view that the Fed should cut rates and suggests lengthening duration for investors concerned about the Fed being behind the curve.

Palantir: Fundamental Strength vs. Valuation Challenge

Gil Laura, Head of Technology Research at DA Davidson, reiterates that Palantir's fundamental results were "spectacular," exceeding all expectations. The company has a run rate of over $4 billion, growing at 63%, with its commercial business more than doubling. He highlights significant customer deals and the government's increasing reliance on Palantir for mission-critical goals.

Laura attributes the stock's decline to a "risk-off vibe" and a "sell the news" situation, rather than any fundamental issues with Palantir itself. He notes that many higher-multiple, AI-exposed companies are also down.

Justifying Palantir's Valuation

The core challenge, according to Laura, is justifying Palantir's valuation. He states that on a price-to-sales, price-to-earnings, or EV-to-cash flow basis, there is "no way to justify Palantir's valuation." It is "completely divorced from fundamentals and from any other valuation of any other company." Investors are buying Palantir based on the expectation of continued growth "for the foreseeable future and beyond." He describes it as a "very individual investor-based stock."

Palantir's Total Addressable Market and Competition

Laura believes there is "no ceiling for Palantir anytime soon" in terms of its total addressable market. He compares its $4 billion run rate to Adobe's $20 billion, Salesforce's $40 billion, and Oracle's $50 billion, indicating significant room for growth.

In terms of competition, while "everybody's trying to do what Palantir is doing," nobody is succeeding as well. Palantir's unique capabilities include helping companies and government agencies collect disparate data sources, combine them for AI use without compromising privacy, and providing end-to-end software and service components. These are difficult to replicate, explaining Palantir's superior performance.

Laura maintains a neutral rating on Palantir because its valuation doesn't fit neatly into traditional financial models, and multiples "matter and have to make sense."

Broader Tech Valuation Concerns and AI Infrastructure

Laura categorizes companies into two groups:

1. Real companies doing real work at attractive valuations: Microsoft, Amazon, Google, and Nvidia. These companies are building AI infrastructure, have seen a positive inflection in AI demand, and are responsibly building compute capacity. They are trading at less than 30 times earnings, which Laura considers attractive.
2. More speculative bets with extraordinary valuations: Oracle, Coreweave, Olo, AMD, and Broadcom. These are more reliant on debt capital, which may become less available.

Laura emphasizes the importance of focusing on "real companies doing the real buildout based on real demand."

Amazon, Alphabet, Meta, Uber, and Lyft: Analyst Perspectives

John Blackledge, Managing Director and Senior Equity Research Analyst at TD Cowan, provides insights into several tech companies:

Amazon

Amazon had a great quarter, and a recent deal with OpenAI has further boosted its stock. Despite a slight sell-off with the broader tech market, Amazon is up 14% year-to-date. Blackledge expects further AWS revenue acceleration in Q4 and beyond, driven by AI demand. He likes Amazon at its current valuation (29 times earnings on his estimates) with a price target of $300.

Alphabet (Google)

Alphabet is up 46% year-to-date, driven by positive regulatory outcomes and strong AI performance across search (AI Overviews, AI Mode) and Google Cloud (Gemini, AI tech stack). Trading at 25 times earnings on next year's estimates, with mid-teen earnings growth expected, Blackledge maintains a positive outlook with a price target of $335.

Meta

Meta shares are up 8% year-to-date but sold off after announcing significant AI capex and opex spending for the next year. Trading at 21 times earnings with low-teen earnings growth expected, Meta needs to clarify its AI strategy. However, its core business has been outperforming, and the AI spend is showing a direct impact. Blackledge has a buy rating and an $810 price target.

Uber

Uber reported good results and a strong guide, with gross bookings beating expectations and a robust Q4 outlook. Despite a 60% year-to-date gain, the stock is facing a tech sell-off. Blackledge notes slightly lower incremental delivery margins, attributed to investments in the grocery and retail vertical, which is growing faster than the restaurant business. He likes Uber despite the current pullback.

Lyft

Lyft is scheduled to report earnings and is expected to deliver good results with mid-teen gross bookings growth and further margin expansion. Despite a 55% year-to-date gain, Lyft trades at less than seven times EBITDA and a 15% free cash flow yield, making it "cheap relative to Uber." Blackledge expects benefits from California insurance relief next year and a general deceleration in insurance cost growth. He likes Lyft going into its earnings report.