{"id":13142,"date":"2023-08-20T11:42:07","date_gmt":"2023-08-20T11:42:07","guid":{"rendered":"https:\/\/isafespend.com\/investing\/why-ai-generated-stock-picks-wont-beat-the-market\/"},"modified":"2023-08-20T11:42:08","modified_gmt":"2023-08-20T11:42:08","slug":"why-ai-generated-stock-picks-wont-beat-the-market","status":"publish","type":"post","link":"https:\/\/isafespend.com\/?p=13142","title":{"rendered":"Why AI-generated stock picks won\u2019t beat the market"},"content":{"rendered":"
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Artificial intelligence can help you beat the stock market, but not in the way most investors think it will. <\/p>\n

The key appears to be investing in those companies that manufacture and support AI\u2019s infrastructure: the chips and networks that enable AI\u2019s machine learning. <\/p>\n

In contrast, investors looking to AI to help construct winning portfolios are likely to be disappointed.<\/p>\n

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Consider the period since late last year \u2014 Nov. 30, 2022 to be exact \u2014 when Chat GPT debuted and AI quickly became the latest Wall Street fad. Through the end of July, Nvidia
\n NVDA,
\n -0.10%<\/bg-quote>
\n \u2014whose computer chips are integral to many AI applications \u2014 gained 176%, compared to just 4.8% over the same eight-month period for the Eurekahedge AI Hedge Fund Index. <\/p>\n

This index \u201cis designed to provide a broad measure of the performance of underlying hedge fund managers who utilize artificial intelligence and machine learning theory in their trading processes.\u201d The average AI-informed hedge fund even lagged the S&P 500\u2019s
\n SPX
\n total return over this period, which was a gain of 13.7%.<\/p>\n

It\u2019s unfair to focus just on Nvidia, since it\u2019s become the darling of Wall Street\u2019s obsession with AI. But the average company in the AI space has also outperformed the Eurekahedge index. For example, the iShares Robotics and Artificial Intelligence Multisector ETF
\n IRBO
\n has gained more than 30% over this eight-month period, for example, more than doubling the stock market\u2019s return and far outstripping the hedge-fund index.<\/p>\n

It\u2019s also unfair to focus on just the period since Chat GPT\u2019s launch, since eight months hardly constitutes a significant track record. But the average AI-informed hedge fund hasn\u2019t made more money than the broad U.S. market over the longer term either, as you can see from the accompanying chart.<\/p>\n

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\n <\/figcaption><\/figure>\n<\/p><\/div>\n

The stock market is the ultimate AI tool<\/strong><\/h2>\n

I will go out on a limb and predict that AI approaches will not, on average, do any better relative to the market than they have since 2009. That\u2019s for a couple of reasons. The first is that, to the extent AI has theoretical value as a stock picker, it will quickly become widely used. In the process, its theoretical advantage will get discounted away.<\/p>\n

Not everyone can be above average, after all. The percentage of advisers and strategies beating the market over the long term will not change after AI becomes widely adopted. As we all know, that percentage is tiny.<\/p>\n

If you have any doubt, read the seminal article from more than 30 years ago by Nobel laureate William Sharpe, entitled \u201cThe Arithmetic of Active Management.\u201d He argued that \u201cafter costs, the return on the average actively managed dollar will be less than the return\u201d of the overall market, and that this conclusion depends \u201conly<\/em> on the laws of addition, subtraction, multiplication and division. Nothing else is required.\u201d<\/p>\n

I hope it goes without saying that AI does not suspend mathematical laws.<\/p>\n

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<\/p>\n

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\n \u201c<\/span> AI can\u2019t know more than the market knows. The best it can hope to do is to match the market over the long term. \u201d<\/span>\n <\/p>\n<\/p><\/div>\n<\/p><\/div>\n

My second reason to predict that AI approaches won\u2019t beat the market is that the market already discounts virtually all the publicly available information that would otherwise be used to train machine-learning models. So, in principle, AI can\u2019t know more than the market knows. The best it can hope to do is to match the market over the long term.<\/p>\n

Think about the potential exogenous global events that could influence the stock market, of which the following is a tiny sample:<\/p>\n