Is it time for advisors to dump AI stocks?

AI stocks appear to be coming off the boil. So should financial advisors sell these names out of client portfolios before they go totally cold? Or sweat out the recent sell-off in case things heat up again?  

The S&P 500 index is up 17% so far in 2023, a not-too-shabby performance when compared to last year’s drop of the same amount. Unless, of course, one compares it to the returns being seen in the artificial intelligence space.

The Global X Artificial Intelligence & Technology ETF (AIQ) tracking the Indxx Artificial Intelligence & Big Data Index, for example, is up a heady 38% year to date. AIQ currently lists 87 globally diversified stocks, so it's less diversified than the S&P 500 despite being an international index. Its top three holdings — Nvidia, Meta and Tesla — are also members of a surging stock group dubbed the Magnificent Seven by Wall Street commentators, along with Apple, Microsoft, Alphabet and Amazon.

All that said, the AIQ has dropped 2% in the past week, leading a number of financial advisors and portfolio managers to debate whether the group’s best days are behind it. 

“The Magnificent Seven led the way during the first half of this year. We've seen the breadth expand beyond those magnificent seven during the second half of the year thus far. But I believe for that rally to continue, we're going to need the Fed to stop this current rate-hike cycle and to know that we've hit a relatively soft landing,” said Kevin Mahn, president and CIO of Hennion & Walsh.

Mahn may be wary of chasing this AI-led rally much higher, but he’s not giving up on AI stocks — at least not all of them. He likens the current AI craze to the late 1990s dotcom boom, which saw many tech leaders grow stronger through adversity while other, more overhyped, underprepared companies crashed. As a result, he cautions investors to do their own due diligence to make sure their AI holdings have “the expertise, the strength of balance sheet and the commitment to AI” to survive.

“One name that we like in that space is Microsoft following their multibillion-dollar investment in ChatGPT," he said. "They still have more money on their balance sheet to invest in AI and ultimately in the AI race.”

As for smaller-cap names, Mahn is a fan of Norway-based Opera Limited due to its AI-enabled search solution Aria.

“How clever is that? Aria from a company named Opera,” he said. “They pay a good dividend and that's a small-cap play. But I once again recommend to investors, do your due diligence. Don't just jump into AI waters. Consider the merits of the companies and the strength of their balance sheets.”

Andrew Graham, founder and managing partner at Jackson Square Capital, prefers to invest in the suppliers of the AI build-out as opposed to the hyperscalers, like Microsoft, Meta and Alphabet, doing the building.

“During a gold rush, you want to invest in the companies supplying the picks and shovels,” Graham said.

The most obvious beneficiary is Nvidia, he said, as servers capable of running AI workloads require the type of advanced semiconductors Nvidia specializes in. 

“The company also benefits through its InfiniBand product, which is the connectivity fabric running the back end of AI server pods. And finally through its software design tool kit,” Graham said of the chipmaker, whose shares are up over 202% year-to-date.

Dean Tsantes, a planner with VLP Financial Advisors, also likens the current AI boom to the internet bubble a quarter century ago, calling the technology “very much still in an infantile stage and too volatile to invest in directly.”

“I would advise my clients to invest a slice of their portfolio in a biotech ETF or health care fund, something well diversified that will rise with the success of AI but also not falter if there is a bubble,” Tsantes said.