AI Boom: Real Transformation with Rational Exuberance Risks

Comparing the AI Surge to the Dotcom Era

Andrew Van Sickle: A prominent recurring topic this year, which also features prominently in one of your major research publications, involves drawing comparisons between the dotcom bubble and the current artificial intelligence boom. What are your thoughts on this? Do you view it as an instance of rational exuberance?

Rob Arnott: Indeed, this represents rational exuberance accompanied by pricing that borders on the irrational. To state it plainly, artificial intelligence is genuinely transformative. There is absolutely no doubt about its potential. It stands poised to reshape our world in ways far beyond our current imagination.

This mirrors the situation back in 2000 with the internet revolution. At that time, proponents proclaimed that the internet would revolutionize every aspect of life: the ways we purchase and vend goods and services; our methods of connecting with loved ones, acquaintances, or business associates; the channels through which we access news; and even our approaches to conducting research. Remarkably, all these predictions came to pass. However, the widespread adoption of the internet occurred more gradually than its most enthusiastic advocates had anticipated, and I suspect a similar pattern will unfold with AI.

One critical oversight in the 2000 narrative was the assumption that the largest companies at that moment would inevitably remain the frontrunners a decade later, let alone two decades on. I remember vividly the chairman of Cisco Systems in 2000, John Chambers, boldly claiming that he foresaw no reason why Cisco could not sustain annual sales growth of 40% for years ahead. Such a growth trajectory would multiply revenues six times over in just five years. In reality, it took Cisco a full 25 years to achieve that sixfold expansion. While still noteworthy, it fell far short of the 40% annual pace. Consequently, investors who held onto Cisco shares from March 2000 have experienced minimal gains or even slight losses.

Among the top ten companies ranked by market capitalization in 2000, only Microsoft retains its position on that elite list today. The remaining nine have all been overtaken by newer challengers. For example, Intel and Nokia were prominent names back then, but superior innovators emerged in chip manufacturing and mobile telephony. Investors often discuss the concept of economic moats—those sustainable competitive advantages that protect a company from rivals—but such defenses are not impervious to erosion over time.

AI Already Challenging Established Market Leaders

We are witnessing early signs of this kind of upheaval in the AI landscape right now. Google’s foundational revenue model relies heavily on generating income from sponsored links and intrusive display advertisements. However, users have increasingly turned to tools like ChatGPT or Perplexity as alternative search engines, which deliver results without the clutter of obtrusive pop-ups or endless streams of promoted sites. There’s no longer a need to wade through numerous irrelevant sponsored pages to reach valuable information. Furthermore, even OpenAI itself faced disruption about a year ago from competitors like DeepSeek.

Thus, we have a rational bubble because AI’s capabilities are undeniably authentic. Every major player in the space has a credible opportunity to emerge as a long-term dominant force. That said, I fully acknowledge that certain frontrunners will inevitably be supplanted by others.

Concrete Examples Demonstrating AI’s Remarkable Capabilities

Andrew Van Sickle: Could you share a specific example from your professional experience that underscores why you consider AI to be the real deal, as you’ve described it?

Rob Arnott: The most recent version of ChatGPT stands out as exceptionally impressive. In our research process, whenever we complete a paper, we feed it into the AI system and request a concise summary along with a critical analysis. We also prompt it to identify any overlooked references or citations that should have been included.

For a paper we finalized not long ago, ChatGPT produced a polished and eloquent synopsis that surpassed anything the original authors could have crafted independently. Additionally, it delivered a comprehensive assessment highlighting the paper’s strengths and weaknesses, complete with a roster of missing citations. Four of these suggestions prompted us to exclaim, “Wow, we absolutely should have included that.” Another four were somewhat relevant but marginal, and two turned out to be nonexistent.

The key takeaway is that AI cannot replicate human-like reasoning or original thought processes, but it excels spectacularly at scanning vast datasets and cross-referencing them against its pre-ingested knowledge base. When dealing with enormous volumes—billions upon billions of data points—it begins to mimic human-level insights remarkably well. Yet, with sparser datasets, its performance falters significantly.

Consider, for instance, analyzing long-term patterns in stock market behavior, where available data might consist of only thousands or millions of points depending on the specific focus. In such scenarios, AI falls well short of the precision achieved by human expertise augmented with standard statistical methods. It proves incapable of forecasting events like market corrections or economic recessions. In essence, AI thrives on sheer volume of quantitative data rather than nuanced qualitative interpretation.

Opportunities in Value Stocks Amid Tech Dominance

Andrew Van Sickle: With the intense recent focus on high-growth technology stocks, where do you, as a renowned value investing expert, identify compelling bargains?

Rob Arnott: The valuation gap between growth-oriented stocks and value stocks remains extraordinarily wide across global markets, approaching all-time highs. In the United States specifically, it rivals the extremes observed at the height of the dotcom mania and during the summer of 2020.

My advice is clear: do not completely forsake growth investments, but avoid overweighting them excessively. Wager against a speculative bubble carries substantial risks, as such episodes often persist and inflate far longer than seems plausible. Therefore, if your portfolio already includes value holdings, it makes sense to allocate additional capital there to balance your exposure.

At Research Affiliates, we consistently prioritize uncovering undervalued opportunities while mitigating concentration risks. This philosophy led us to develop the Research Affiliates Fundamental Index (RAFI) series back in 2005. These indices deliberately tilt toward value characteristics by weighting companies according to their fundamental economic scale—factors like sales revenue, cash flow, book value, and dividend payouts—rather than fluctuating share prices. This methodology has consistently outperformed traditional market-cap-weighted value indices, delivering superior results in three out of every four years.

Investors seeking practical implementation might explore the RAFI-based exchange-traded funds (ETFs) offered by Invesco, which emphasize value strategies. Options include the FTSE RAFI All World 3000 UCITS ETF for broad global exposure; the FTSE RAFI US 1000 UCITS ETF targeting American value plays; its European equivalent, the FTSE RAFI Europe UCITS ETF; and the FTSE RAFI UK 100 UCITS ETF for a UK-focused approach.

Gold’s Medium-Term Prospects Amid Debt Concerns

Andrew Van Sickle: Shifting gears to gold, it seems to be taking a brief pause after recent advances. Do you still hold a bullish view for the medium term?

Rob Arnott: The most compelling bullish driver for gold stems from the developed world’s persistent reliance on debt-funded government expenditures. There looms a genuine concern that fiat currencies could precipitate a financial crisis surpassing the severity of the 2009 global meltdown—a scenario I deem quite plausible.

That said, I do not perceive this as an immediate danger on the horizon. Much like Greece eventually confronted the consequences when its debt ballooned toward 200% of GDP, the United States is not exempt from similar fiscal dynamics. Despite being the world’s largest economy, we cannot indefinitely finance spending through borrowing without repercussions. Such a tipping point might materialize within the next ten to fifteen years.

Resolving the debt burden would likely demand a sharp spike in inflation to erode its real value, which in turn would vindicate today’s gold enthusiasts regardless of current elevated prices. Nevertheless, I am not advocating a bullish gold stance for 2026, considering the asset’s recent climb to fresh record highs and the evident speculative froth surrounding it.

Potential Impacts of Political Influence on Interest Rates

Andrew Van Sickle: What might be the consequences if Donald Trump seeks to exert influence over the interest rate decisions made by the US Federal Reserve?

Rob Arnott: The likely outcome could involve maintaining rates 1% or 2% lower than economic fundamentals would dictate, effectively creating an environment of artificially cheap money—defined as nominal rates falling below inflation levels, resulting in negative real yields. The United States endured a dozen years of such conditions, which significantly contributed to subdued economic growth.

The core problem is that monetary stimulus rarely delivers the intended economic boost. My colleague Chris Brightman has extensively documented how such policies fail to foster enduring, robust growth. Instead, they fuel asset price bubbles, widen wealth disparities, and channel funds preferentially to affluent individuals who then deploy it in ways that inflate corporate earnings and propel stock markets higher.

Recent stimulus efforts have also incorporated substantial fiscal components, whereby governments extract funds from the private sector via taxation or borrowing before redistributing them. This mechanism inherently limits its capacity to invigorate genuine private-sector enterprise.

US Inflation Outlook and the Role of Tariffs

Andrew Van Sickle: What do you foresee for US inflation trends? Could proposed tariffs exacerbate it?

Rob Arnott: A resurgence in inflation could arise from unchecked government overspending, a practice that persists unabated and thus poses ongoing risks. However, I do not regard tariffs themselves as a major inflationary force. Recall how, just over a year ago, numerous analysts raised alarms over the prospects of a severe recession coupled with hyperinflationary pressures.

Let us examine the mechanics logically. Should tariff rates stabilize at an average of 15%, this equates to a targeted 15% value-added tax imposed exclusively on imports—not a recipe for catastrophe. It functions as a straightforward tax that elevates costs on affected goods. Given that US imports constitute about 11% of GDP, a 15% average tariff would generate approximately 1.6% of GDP in additional revenue, mirroring historical precedents.

The incidence of this burden is distributed: suppliers absorb a portion to preserve market competitiveness; intermediaries in the supply chain shoulder some; and consumers bear the remainder—perhaps around half, or 0.8% of GDP—as a singular, non-recurring hit. As a proponent of libertarian principles, I advocate for a zero-tariff ideal. Yet, these measures are unlikely to propel inflation into the stratosphere.

Trump’s tariff maneuvers evoke strategies from Sun Tzu’s The Art of War: instill fear in your opponents to secure victory without direct confrontation. He routinely threatens extreme measures like 100% tariffs but ultimately settles for far milder implementations—a tactic he has employed throughout his career.

China’s Economic Path Under Xi Jinping

Andrew Van Sickle: In our previous discussion, you noted that China had adopted a more statist orientation under Xi Jinping’s leadership. Recently, he has emphasized elevating support for the private sector. Does this signal a recognition that greater free-market reforms are essential to extricate China from its debt-deflation trap?

Rob Arnott: Xi Jinping remains a staunch, unrepentant Maoist at heart, so any rhetorical nods toward the private sector are unlikely to translate into substantive policy shifts. I continue to believe that China will age demographically before achieving true prosperity.