Is the AI Rally Sustainable?

Table of Contents

Introduction

Nvidia shares have surged over 15% and added more than $200 billion to its market cap following their impressive earnings results. This rally in the AI field indicates that there is still more room for growth. However, there are concerns about whether this market hype poses a potential risk to the broader market. To gain insights into the longer-term implications, we turn to Jeff Beerman, the Chief Market Technician at Theotrade.

The Real Deal: AI Has Arrived

Jeff Beerman clarifies that it is not hype but a reality that AI has arrived. Nvidia’s earnings have been exceptionally strong, with no signs of negativity. Although they have provided higher guidance for the next quarter, the critical question is how far forward AI stocks have priced cash flow, earnings, and valuations. Jeff acknowledges that, at present, it is challenging to determine the exact timeline, but he warns that the market is currently overbought.

Overbought Levels as a Warning Sign

Overbought should be seen as a condition and not an immediate trigger for selling. While overbought conditions can persist, they serve as a warning that the market may be getting ahead of itself. As managers throw caution to the wind and chase after AI-related stocks, there is a concentration risk. This means that many managers are overlooking potential opportunities in other sectors, resulting in a skewed focus on AI stocks.

The Concentration Risk

Concentration risk is a significant concern. Many managers are abandoning diversification strategies and gravitating towards what is currently working in the market. This has led to a disproportionate allocation of assets to the financial and tech sectors. Financials, in particular, have become disconnected from interest rates. While interest rates are rising, financial stocks continue to climb. However, if both the tech and financial sectors become fully priced simultaneously, it could pose a risk when a corrective period occurs.

Technical Indicators

Jeff Beerman suggests looking at technical indicators to determine when Nvidia may be overextended. He recommends analyzing standard deviation channels and the Relative Strength Index (RSI) over various timeframes. He notes that Nvidia’s RSI on a monthly basis is approaching the 75 to 80 level, which indicates an overbought condition. Recently, Nvidia’s RSI on a daily basis hit an all-time high of nearly 98. When crowded trades like Nvidia start to unwind, it can lead to dislocations and gaps in the market.

Separating the High Octanes from the Low Octanes

Jeff Beerman distinguishes between high octane and low octane stocks within the AI sector. High octane stocks such as Nvidia, Alto Networks, CrowdStrike, and SMCI are at the forefront of the AI revolution and are driving the market’s excitement. On the other hand, low octane stocks like Microsoft and Alphabet are not as overbought or overpriced. While there may be disappointments along the way, Jeff reiterates that AI is here to stay.

Frequently Asked Questions

1. What is AI?

AI refers to artificial intelligence, which is the development of computer systems that can perform tasks that typically require human intelligence, such as speech recognition, decision-making, and problem-solving.

2. How has Nvidia’s earnings impacted the market?

Nvidia’s impressive earnings results have caused its shares to surge over 15% and has contributed significantly to the company’s market cap. This rally suggests that there is still more room for growth in the AI field.

3. What is concentration risk?

Concentration risk refers to the potential negative impact on an investment portfolio when there is a heavy concentration of assets in a particular sector or group of stocks. In the context of the AI rally, many managers are solely focused on AI-related stocks, which may result in missed opportunities in other sectors.

4. How can technical indicators help identify overbought conditions?

Technical indicators, such as standard deviation channels and the Relative Strength Index (RSI), can provide insights into the market’s overbought conditions. By analyzing these indicators, investors and traders can determine if a stock or market has become overextended and may be due for a correction.

5. Is the AI rally sustainable?

While the AI rally has shown significant growth and potential, there are concerns about the sustainability of this market hype. The concentration of investments in AI-related stocks and the disconnect between financials and interest rates pose risks to the broader market. However, AI is a promising field that is expected to continue evolving and influencing various industries.

Summary

The recent surge in Nvidia shares and the broader AI rally indicates that the AI revolution is in full swing. However, caution should be exercised as the market may be overbought, and there is a concentration risk in the AI sector. Traditional risk management and diversification strategies are being challenged, with many managers gravitating towards AI-related stocks. It is essential to monitor technical indicators and be aware of potential overbought conditions. While there may be uncertainties and disappointments along the way, AI is here to stay and will continue to shape the future.

Additional Resources

If you want to learn more about the AI revolution and its impact on the market, check out the following video: AI Revolution: Market Implications.

This blog is for informational purposes only and does not constitute financial advice. The information provided in this blog is based on publicly available information and the author’s analysis. The author does not guarantee the accuracy or completeness of the information presented. Investing in the stock market involves risk, and individuals should conduct their own research and consult with a financial advisor before making any investment decisions.

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Indranil Ghosh

Indranil Ghosh

Articles: 260

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