Can AI beat the stock market? In the long run, don't bet on it (2024)

Can artificial intelligence beat the stock market?

It’s a tantalizing thought that has captured the imagination of everyday investors and the attention of many in the investing industry, where more than half of asset managers are already using the technology in either direct investment strategies or asset class research, according to a recent report by Mercer LLC.

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But while computers and algorithmic trading have been delivering outsized returns to a small handful of highly sophisticated players for decades, those hoping to strike it rich on the back of the current wave of popular AI technologies might be in for a reality check.

That was the conclusion of a July report from Moody’s Ratings, which said AI gains at mutual funds, banks, insurance companies and the financial research industry are much more likely to come from efficiencies in operations, including risk management, than from an ability to pick winners.

“While the headlines may focus on ‘AI-enabled Alpha,’ the real impact will be from automation gains by deep adopters who can realize AI efficiencies above their AI implementation costs,” the report said.

It’s a thesis that Thomas Holloway, an associate professor of finance at the University of Calgary’s Haskayne School of Business, agrees with.

He said early adopters may get a temporary edge, but with widespread adoption, that edge will disappear, much like an athletic innovation can be wiped out in a competitive sport such as swimming once everyone is using it.

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“When a new technology comes along, it’s like a new swimsuit: a few people adopt it and look weird, and then they win all the races, and then everyone else says, ‘Oh, man, I should probably get that swimsuit, too,’” he said. “Using public ChatGPT on standard public data could have an edge for a while, but is likely to become standard use and, therefore, offer no edge to create alpha.”

Nevertheless, Holloway predicted asset managers will attempt to use the technology in the early years to beat markets.

“I think it’s going to be a really exciting period, for maybe a few years, where some investors will get an advantage by using the tools in more creative ways,” he said.

Long term, there could also be changes at the margin, through — for example, changes to the skills needed to excel at investing in the coming decades.

“You might not need to be such a pro at financial statement analysis because some of those details can be taken care of,” he said. “It might (become) more creative … like asking kind of weird questions and really pushing the AI and exploring in different directions could be more of an edge than before.”

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The Moody’s report left less wiggle room.

“AI will not deliver sustained market outperformance for the industry,” it said. “The enduring impact of AI on the industry is therefore likely to be cost savings rather than investment outperformance.”

Among the reasons noted in the ratings agency’s assessment is that the fundamental nature of markets is that for every winner, there is a loser on the other end, which means passive investors in particular will see little change in indexes.

“As with the game of poker, outperformance in the stock market is a zero-sum game,” Moody’s said. “Just as better gambling tools used by a group of players at a poker table will not change the size of the pot, advanced AI will not enable all asset managers to outperform the market. This is a dynamic that transformational technologies through history, including the telegraph, computer, fax machine, Internet and mobile phone, have been unable to change.”

The report also pointed out that even though previous innovative information technologies gave a temporary edge to early adopters, they ultimately “democratized” access to knowledge.

“As the printing press democratized reading and the Internet is helping to democratize knowledge, artificial intelligence could help democratize analysis generally and financial analysis specifically, helping to narrow the gap between professional and retail investors,” Moody’s said.

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