Three Thought Thursday

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Dear Reader,

I still feel nostalgic thinking about driving back from GameStop (before it became a meme) with the newest addition of Madden, FIFA, or Call of Duty (when Mom finally lets us play). Every year, the talk among us pre-pubescent boys was, “Did you see how much better the graphics look this year?”

Fast-forward 15 years, and the graphics just got much more interesting.

Nvidia, the company behind the revolutionary video game graphics of the early 2010s, is about to surpass Apple as the second most valuable company in the world.

Why?

The AI boom.

Nvidia used to lead the way in video game graphics, but they pivoted.

Now, they have a stranglehold on manufacturing the computer chips used to power the crazy AI tech you see all over the internet.

With every major company trying to implement AI, Nvidia makes the “secret ingredient” that lets companies build and use AI products.

When trillion-dollar companies knock on your door wanting your product, you will be rolling in some serious dough…

For now.

How much revenue do these major companies (Amazon, Microsoft, and Google) generate from AI?

$20 billion.

Now, that seems massive until you realize that those same companies have increased in value (how much they are worth) by $3 TRILLION.

Or a 150X multiple of revenue.

For context, you’d be extremely lucky (and have an amazing company) if your business traded at a 7X multiple.

Trading at 21 times what was previously considered an outstanding multiple means one thing.

AI has become a bubble.

This gets me both excited and nervous, as my generation (Gen Z) has never been old (or mature) enough to experience a previous bubble (or its pop).

This all got me thinking about one thing:

Bubbles—that’s the theme for this Three Thought Thursday.

Imagine a Time Before the SEC

There was a family even more popular than the Kardashians “back in the day.” Do you have an idea of who I’m talking about? The Kennedys! The industrialists, public figures, and politicians became the most influential family in the latter half of the 20th century. The most important member of the family? While JFK might seem like an easy answer, his father, Joseph, is seen as the Kris to the Kardashian’s Kim. It can be reasoned that Joe built his family empire using the wealth he accumulated (and luckily saved) during the first economic bubble. The one that caused the Market Crash of 1929 (and the impending Great Depression). The reason behind this first bubble? Speculative optimism. No one had seen growth in the stock market like when it peaked in August of 1929. Everyone assumed it would keep going up, and their optimism led to many “smart” investors using new tools like margin buying and leveraged credit loans to multiply the wealth already being created, leading to an even more inflated market. As soon as the market corrected itself, panic selling began, banks failed, and confidence was shattered. The financial system was unregulated, so the government created the SEC to regulate and prevent irresponsible financial practices. Who stepped into the role as first chairman of the SEC? Just a man who got lucky and sold most of his stock right before the crash: Joseph Kennedy.

The first bubble grew due to precedent, optimism, and no regulation.

A Bubble Made from Silicon

The birth of everyone’s favorite generation (Gen Z, of course) was only the second most impactful creation of the late 90s and early 2000s. The creation of the Internet ushered in the most valuable companies, products, and opportunities of all time. With this new era came enormous hype, capital, and IPOs. Everyone and their mother seemed to be raising venture capital for the next big internet company (even for ones that had never been profitable). Red flag? Even crazier were the companies going public — getting IPO valuations so inflated that every retail investor (average investor like you and I) wanted a piece of it. What happens when you get tons of venture capital and even more investor capital pumped into an economy full of these kinds of businesses? A bubble forms. What causes a bubble like this to pop? Pets. Pets.com, to be exact. Pets.com went public in 2000, garnering a valuation of over $100M. 9 months later, they filed for bankruptcy due to a terrible and unsustainable business model. Shareholders of the company lost everything. Now, Pets.com was not the sole reason behind the .COM bubble collapse. Still, the reasons why they failed (unsustainable business model, overvaluation, and market saturation) led many investors to realize their mistakes and begin a sharp sell-off. The .COM bubble burst.

The .COM bubble grew due to unsustainable and overvalued businesses.  

Homes: Where Finance Bros Messed Up

Could you imagine a bet so big that someone makes a movie about it? I don’t think Michael Burry was thinking that when he convinced his hedge fund to jeopardize the entire company off one single bet (The Big Short). Burry was a hedge fund manager who noticed a bomb right before it exploded. Funny enough, many of his “finance bro” peers set the detonator without realizing it. In the mid-2000s banks and lenders began handing out sub-prime mortgages like they were candy. They were given to borrowers with poor credit. The increased risk led to greater interest, which meant more moolah for the banks. Combine those with fancy and complicated financial tools (MBSs and CDOs), which double down on these sub-prime mortgages, and the rich were rolling. A mortgage bubble was formed. When the entire foundation of your money-making machine is reliant on mortgage owners who don’t have a great track record of being able to pay off their mortgage, you may just be the biggest idiot known to man. The mortgage bubble swiftly and brutally popped when those very borrowers defaulted on their mortgages.

The Housing Market bubble grew with rich people trying to get even richer.

Three different bubbles from three different eras. A fourth bubble is on the way. The question is…

What’s going to make it pop?

Can you do me a favor? If you learned something new in this edition, forward this letter to a friend who may not know about one of these three stories.

See you next Thursday,

Tommy