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Let's agree or assume that at some point in the future, an event will happen that will cause most AI startups to go bankrupt, and that this will drag down the overall stonk market.
We should already know that event will look like: a company or companies burning through the last of their cash and being unable to raise further funds from VC's or public debt or equity markets.
That's what happened with the dot-com bubble, and the resemblances with today's AI market are striking. If you're not old and crusty, [read up](https://en.wikipedia.org/wiki/Dot-com_bubble) on it.
This process will start with the weakest of the AI hype companies.
1. This weakest large AI company will ask their VC firm for more money and the VC firm will say no, we're giving up on you guys. That means no one else will give them money either. Without a source of fresh capital to burn, bankruptcy will be imminent for this weakest AI company.
2. This event will discourage other investors and VCs from buying into other AI hype companies. Stocks will be spooked.
3. Then the VCs bankrolling the 2nd weakest AI firm will hold off on their next round of funding, because events suggest they might not be able to sell their company's equity to greater fools and might be better off cutting their losses.
4. At this point, a wave begins where everyone is afraid of putting more money into AI companies, and the stocks of big tech companies fall as investors assess the probability of more bankruptcies.
5. All stocks fall hard, even the eventual winners. See how Amazon's stock lost most of its value during the dot-com bubble. Same thing with Amazon, Cisco, and plenty of other household names.
As an investor in stonks, you are betting that this sequence of events won't happen this year. It only makes sense to own ANY stonks if we think it is improbable that the event could occur in the near future.
Let's put this in oversimplified binary terms for illustration.
Scenario A: Tech stocks gain 20% in 2026.
Scenario B: Tech stocks lose 50% in 2026.
Now let's assign probabilities and expected values. If Scenario A has a 75% probability and B has 25%, then the expected value would be:
(0.2\*0.75)+(-0.5\*0.25)
(0.15)+(-0.125)
=2.5%
One year treasuries are yielding 3.6%, so if those were our estimates we should prefer to buy the treasury bonds over tech stocks.
We can work the equation backward to find the estimated probabilities at which an investor would be indifferent to tech stocks vs. treasuries. E.g. at probabilities of 80% and 20% the EV rises to +6%. However, at 70%/30% the EV falls to -0.1%.
Basically, at some level of perceived riskiness, this market doesn't make sense. Volatility reflects tiny changes in investors' attitudes about the odds.
Another angle: A 25% chance of the bad outcome implies that we think the event must occur sometime within the next four years. Does that sound reasonable? Would the next 2 years be more reasonable (50% chance)? What about the next 5 (20% chance)?
How long can fresh cash from investors sustain the burn rate of some critical mass of the destined-to-bankruptcy companies? The trigger event will probably be some critical mass of companies (or a company) being unable to obtain their (or its) next round of investor capital. So how long until the weakest AI company falls?
Interestingly, if a VC firm funding the weakest AI startup decided not to grant the company another round of cash, it would make sense for this VC firm or its insiders to short the market, because they would know their decision will set off a market selloff. Also, this VC firm would know that if they did continue to fund their weak startup, the VC firm funding the 2nd weakest startup would face the same choice.
Thus, the VC firms or their insiders must choose to either crash the market and profit from shorting the crash they cause, or possibly allowing someone else to crash the market and only suffering losses.
Either way they know the worst AI startups aren't going to make it and they know they control the timing of the eventual crash. They'll do the logical thing and try to pull the rug before anyone else does.
Just something to be aware of when estimating when the VC money will run out!
Positions:
* $3500 USD worth of Swiss Francs
* $100k USD in Gold ETFs: IAU, SGOL, IAUM
* Options hedges against QQQ and IWM stock positions, setting a firm floor on potential losses (this makes my odds calculation a lot different)