The Red Flags are Piling up. Time to go Short?

No one can say how long the AI hype will last. Here are some worrying observations from this earnings season and how I am preparing for a potential crash in AI stocks.

I don't know if it's because of Donald Trump taking office or the course of the reporting season so far. But I've been seeing more and more red flags in the last few days and weeks, which are making me increasingly pessimistic about the further development of many popular tech stocks.

I have warned here several times about the bubble that has formed around AI. Yes, it is true that AI is much more than just hype and will change the world just as profoundly as the internet did 25 years ago. But just as the dotcom bubble burst during the disillusionment phase of the internet hype, so it will be this time too.

As in the past, some of the first movers, who are now considered flagship companies of AI, will disappear into nowhere. Only the older ones will still remember with me the Netscape Navigator as the world's leading browser or Compuserve as the world's largest online portal after the emergence of the Internet.

Will OpenAI end up like Netscape?

The stocks of leading network infrastructure manufacturers lost more than 90% of their value at the time after the end of the internet boom. Even though they were often economically successful for decades afterwards.

Will Nvidia suffer a similar fate to Cisco back then?

I wouldn't bet against it.

Here are a few observations of some red flags that I noticed during the past earnings season:

🚩 Excessive Infrastructure Investments by Cloud Providers

History is repeating itself. As at the dawn of the internet, infrastructure providers are investing too much because they are unable to meet short-term demand and the current gold rush means that long-term demand is being overestimated.

Alphabet shocked investors when it presented its latest financial results by announcing that it plans to invest a whopping $75 billion in 2025. Amazon went even further and announced that it plans to spend more than $100 billion on capital expenditures in 2025. The lion's share of this will go towards expanding new data centres to satisfy the hunger for resources of AI applications.

In the age of AI, Big Tech is increasingly becoming a capital-intensive business. This is already putting pressure on cash flow and will increasingly weigh on profits in the medium term due to ever higher depreciation. Alphabet's depreciation already rose by almost 30% in 2024 and will skyrocket even faster from 2025 onwards. So far, the financial market has not taken into account that the revenue quality of Big Tech is declining due to AI because of the higher capital intensity.

Valuations with cash flow multiples of over 30 are far too high for Big Tech and could only be justified if growth rates, driven by AI, were to rise sustainably above 20% again and gross margins were to rise to 70-80%, as they do in good SaaS companies. I see no sign of this at Microsoft, Alphabet, Amazon or even Apple. All these stocks are therefore significantly too expensive.

🚩 Serious allegations against Nvidia

I had publicly considered here on my SubStack last week what DeepSeek really means for tech stocks.

The Nvidia Short case quoted in this article sounds very convincing to me. The negative picture is confirmed by the report of an investigative journalist who found that, despite US sanctions, Nvidia chips have appeared in large quantities on Asian trading platforms. Thereafter, there were indications that Nvidia, together with companies such as Supermicro (SMCI), may have facilitated illegal exports to China and other sanctioned countries through third-party vendors and third-party countries (Singapore).

The suspicion that Nvidia and partner companies knowingly participated in circumventing export restrictions is a serious one and will not be ignored by the Trump administration. In my opinion, a major storm is brewing over the future of Nvidia, at least in the medium term. I am curious to see whether the expected good numbers for 2025 can obscure this.

🚩 The Palantir Hybris

The latest earnings call from Palantir was difficult for me to bear. The company reported outstanding figures for Q4 2024 that were almost too good to be true. The fact that the company had achieved an incredible Rule of 40 Score of over 80 was emphasised again and again. Hardly anyone realised that the high cash flows left hardly any net profit for shareholders due to absurdly high share-based compensation.

Competitors and customers are treated from the company with as little respect as the analyst community. For CEO Alex Karp, all critics are non-believers. The Palantir stock is valued at more than 85 times revenue by the stock market. This has nothing to do with the real value of the company in the real world. We have seen where this leads in the cloud bubble until 2021. A crash of the Palantir share price is only a matter of time.

🚩 Tesla's Bullshit Bingo

Equally hard for me to bear is the part-time CEO of Tesla. At the last Earnings Call, he didn't even address the weak business figures, but countered them with the prospect of autonomous driving (in June, in Austin, Texas, with guaranteed good weather ;-) and the humanoid robot Optimus.

Elon doesn't seem to be interested in the fact that Tesla is currently selling significantly fewer cars in many markets. In Europe, many people are now ashamed to drive a Tesla and be seen as a Musk supporter. In January, Tesla's sales plummeted 63% in France, 60% in Germany, 44% in Sweden, 38% in Norway and 42% in the Netherlands. Nine months ago, I speculated - not entirely seriously at the time - whether Tesla could get out of the electric car business. This absurd scenario no longer seems so far-fetched to me.

The most important quote from Elon Musk's latest earnings call:

‘There is a path where Tesla is worth more than the next top five companies combined.’

Aha... so that would be $14 trillion - which would be another ten-bagger if you invested in Tesla stock today. It makes my hair stand on end, but masses of retail investors actually still believe everything that Elon says.

🚩 The Euphoria of the Finfluencers

The many far-reaching finfluencers who spread Elon's message among their followers also contribute to this. To this day, I don't understand why some people uncritically spread the messages of Elon Musk and Alex Karp with an almost religious devotion.

All I know is that this social media is influencing legions of retail investors whose portfolios are full of Tesla, Palantir, Nvidia and other high-flying stocks. In most cases, the cluster risks go undetected, and many people enjoy exorbitant book gains in their portfolios. This goes on until the bubble bursts. Easy come, easy go.

I cannot emphasize enough the importance of taking profits from time to time and making sure you have a well-diversified portfolio.

Can You Prepare for a Possible Crash?

So for me, the question once again arises as to how one should behave as an informed tech investor if one assumes a crash in the stock markets. Because let's face it: if Nvidia, Tesla, Palantir and Co. crash, if Big Tech seriously corrects, then it will shake the stock markets as a whole.

Getting out of tech stocks altogether is not an option for me. If only because I don't know how I could invest my assets better in the long term. In my 35 years on the stock market, I have already had to watch my stock portfolio halve in value three times and yet I can still look back on a significant double-digit return over the long term.

Nobody can say how far this AI hype will go. Timing a crash is almost impossible or a matter of luck. Not being invested has usually been a mistake in the past.

I am therefore preparing for a tech crash with the following 4 measures:

1. Valuation Matters

The highly weighted stocks in my portfolio are all stocks that have not benefited from the AI hype and are fundamentally very fairly valued. I wrote about these “high-conviction” investment cases including Vimeo (read here), IAC (read here) , PayPal (read here) , Warner Bros. (read here), LendingClub (read here). I expect that these stocks will suffer only briefly in the event of a broad crash.

2. Profit Taking

I have already almost completely eliminated stocks that are among the so-called AI winners from my portfolio and realized high triple-digit profits. I only still hold small residual positions in Arista Networks, Pure Storage and Alphabet in my portfolio.

3. Keep Powder Dry

I have increased the cash reserve to around 10% through profit taking and will increase it further if necessary.

I expect that in the event of a crash, in addition to the AI winners, highly valued SaaS companies will initially be sold off sharply. In my portfolio, stocks trading at double-digit EV/Sales ratios (Duolingo, Monday, GitLab and Veeva) should then fall significantly in price.

Nevertheless, I will remain invested in these stocks, but only with a medium weighting. In the event of a crash, I would buy these stocks with conviction. I am convinced that these companies will be worth significantly more in the medium and long term than they are today. However, temporary price pain in the event of a market downturn must be taken into account here.

4. Shorting Crash Candidates

Since 2022, I have gained some experience in short selling stocks. Before that, I was a long-only investor for 30 years. Then came the tech crash in 2022. And I was extremely annoyed. It is true that I had correctly assessed the overall situation regarding the generally completely overvalued cloud stocks in the run-up to this bear market.

But due to my long-only strategy, I still had to witness how my own portfolio was badly affected in 2022. At one point, my model portfolio lost 50% of its value. For the third time in the past 30 years (after the bursting of the internet bubble at the turn of the millennium and the financial crisis of 2008/2009), I was unable to escape the bear market. How could I: a long-only strategy simply means that there is no way to profit from falling prices.

That's why I started experimenting with short-selling stocks back then, and today is the first time I've felt the time had come to talk about it in public: Since 2022, I have been managing a Long/Short Portfolio on eToro under the username @stwBoerse, which is publicly accessible. If you look at this portfolio, the first thing you notice is the +200% return that I have been able to achieve overall with a long/short strategy over the last two years.

Please do not take this performance figure too seriously. It is merely the positive result of my tests of the eToro trading platform. This performance has been achieved with small money and an increased risk. Such a performance is NOT to be expected in the future and is unrealistic.

In this eToro long/short portfolio, I invest not only in the long investment ideas known from this substack but also, depending on the market situation, in short positions of absurdly overvalued stocks. Currently, I have sold short Palantir, Tesla, Nvidia and C3.AI.

Finally, I would like to issue a warning about shorting stocks:

Shorting Stocks Can be Dangerous

Yes, I am now actually convinced that as an EXPERIENCED market participant (this caveat is very important), one can successfully use one's fundamental knowledge of individual stocks when they are overvalued to make money by shorting them.

However, the instruments of short selling can be very dangerous for inexperienced investors. It's like driving a car: it's not a good idea to put a Porsche in the garage of a novice driver. No matter how easy it is to drive, the risk of an accident is simply higher for a beginner than with a small compact car.

Please approach this topic, which is certainly as exciting as it is potentially lucrative, with the appropriate caution. Numerous statistics show that most retail investors lose money when speculating on falling prices. So I have now joined eToro to prove the opposite for myself.

I will document on this Substack how this experiment develops in the long term. I expect that my long/short portfolio will perform worse than my long-only model portfolio in good stock market times, while it should perform better in bad stock market times.

If you are interested in the portfolio of my long/short strategy, you can view it here at eToro. In a future post, I will explain in more detail why, after a long evaluation, I decided to implement my long/short strategy on the eToro platform.

If you don’t want to miss further reports on my long/short investment experiences, you can subscribe to my 100% free Substack here:

Disclaimer: The author and/or persons or companies associated with him hold short positions in Tesla, Palantir, Nvidia and C3.AI (as of 8th Feb 2025). The author and/or persons or companies associated with him are related to eToro through an affiliate partnership and the Popular Investors Program. This post represents an expression of opinion and not investment advice.