Patrick Boyle, one of my favorite analysts, discusses the Anthropic IPO and the AI stock bubble in his usual deadpan sarcastic (but data-supported) way.

YouTube: Is the AI Bubble About to Be Tested? (Patrick Boyle)

It’s worth investing a half hour in this video. Boyle’s takeaways are many but the bottom line is that investing in a stock IPO for $2 trillion of a frontier AI company with relatively minimal profits from actual end-users at a time that open source models and technology to route end-user AI queries to the cheapest, most distilled AI apps and price competition may not be the best use of investors’ hard earned cash.

I especially enjoyed Boyle’s reference to Scott McNeely’s famous 2002 Post-Dot-Com quote which highlights the stark mathematical reality of current valuations.
Here is the full excerpt from Scott McNealy’s April 2002 interview with BusinessWeek, reflecting on Sun Microsystems trading at 10 times revenue at its dot-com peak:

“At 10 times revenues, to give you a 10-year payback, I have to pay you 100% of revenues for 10 straight years in dividends. That assumes I can get that by my shareholders. That assumes I have zero cost of goods sold, which is very hard for a computer company. That assumes zero expenses, which is really hard with 39,000 employees. That assumes I pay no taxes, which is very hard. And that assumes you pay no taxes on your dividends, which is kind of illegal. And that assumes with zero R&D for the next 10 years, I can maintain the current revenue run rate. Now, having done that, would any of you like to buy my stock at $64? Do you realize how ridiculous those basic assumptions are?”

I had several chuckles along the way. When Boyle says something that doesn’t seem to make sense on its fact, understand that he’s just being sarcastic in his usual deadpan style.

Investors need to base valuations on profits, not on revenues. Estimating the value of a company on the TAM, which stands for Total Addressable Market - is pure wishful thinking that doesn’t take competition and pricing cycles into account. In the video, he discusses how tech companies and investment bankers use TAM figures—which describe the total potential revenue available if a company were to capture 100% of its target market—to justify massive, multi-trillion-dollar valuations. That’s pure speculation and was the inflator of the dot-com bubble.

I wouldn’t touch the Anthropic IPO with a 10 foot pole. Nor would I buy any bonds offered by any AI or AI-adjacent company.

40% to 45% of the S&P 500 is comprised of companies explicitly tied to the AI ecosystem (enabling hardware, hyperscale cloud infrastructure, power/utilities, and core software platforms). Roughly 60% to 75% of total index returns since the start of the current AI expansion cycle (late 2022 through 2026) have been directly generated by AI-linked companies.

The rise of high-capability open-source models, model distillation, and rapid hardware efficiency optimizations acts as a major deflationary force on model providers’ pricing power. The current trajectory of capital expenditure versus real end-user revenue is structurally unsustainable.

According to Gemini: Absent a sudden macroeconomic shock, a margin-driven valuation correction is most vulnerable to occurring over a 12 to 24-month horizon. The tipping point will arrive when hyperscaler management teams signal a deceleration or flatlining in capex growth, triggering an immediate multi-multiple contraction in high-P/E hardware and semiconductor suppliers.

It’s typical of end-stage bubbles to attract investors who feel so smart because their brokerage statements are growing rapidly. (This was true even before there was such as thing as a brokerage statement - cf. “Manias, Panics and Crashes.”)

This bubble won’t pop suddenly because some of the hyperscalers have massive revenues to support their capex. But they are already borrowing huge amounts. Interest rates are rising. When the boardrooms start to pull back because the revenues don’t support the capex, the whole ecosystem will implode. Not overnight. Maybe starting with a plateau of the SPX as we are seeing now.

One way to protect against extreme valuation concentration is to move assets from a cap-weighted to an equal-weighted SPX.

The divergence between the Equal-Weight S&P 500 (RSP / S&P 500 Equal Weight Index) and the Cap-Weighted S&P 500 (SPY / S&P 500 Index) across the three major downturns highlights a critical rule: Equal weighting excels when a downturn is driven by valuation multiple compression in mega-cap tech, but offers limited protection during broad, credit- or demand-driven economic recessions.

The conservative investor will select stocks of growing companies with low P/E ratios in industries that aren’t heavily cyclical, coupled with a ladder of short-to - moderate duration TIPS (or A rated and better bonds). Index investors will shift to equal-weight funds since GDP growth is currently strong and there’s no sign of a recession.

Wendy