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May 30
2024

Deciphering the AI Hype: Can Artificial Intelligence Beat the Market?

From generating professional headshots to writing compelling content, many are buzzing about the illustrious phenomenon of artificial intelligence. But to what end? And the bigger question on the minds of many in the financial industry: Can AI beat the market?

While the AI intrigue is relatively new, Wall Street has been attempting to use computers to make decisions through algorithms for nearly 40 years.1  For decades mathematicians and broker dealers have been attempting to build trading models that analyze historical data and market trends with little to no human input through models that attempt to extrapolate from past data to identify patterns with limited human input.2 The result? Little to no correlation between machine powered trading platforms and unparalleled success.1

At a time where many people are wondering what AI can’t do, read on to find out why beating the market is still on the list…at least for now.

Markets are Efficient

Largely, markets are efficient.  “All of the knowable information is already in the price today,” says Mark Matson, Founder and CEO of Matson Money. “Only unknowable information can change the price moving forward.”  As reflected in the Efficient Market Hypothesis, current stock prices are fairly valued because they reflect all existing information at the time they are sold and therefore, stock picking or market timing in an attempt to outperform the market is highly unlikely and achievable only by luck.6 Because of this, no person – or computer, including AI investment management – can consistently or accurately predict the price of a particular stock in the future.  AI investment bots use past data to make decisions, therefore, their analyzation can become obsolete based on the swift movement of evolving markets.5

The World Can Be Unpredictable

A significant amount of market fluctuation is influenced by factors that are inherently uncertain.  AI investing bots can’t predict war, global unrest, political outcomes, economic factors, or natural disasters. It relies heavily on historical data and trends to make predictions, struggling to account for random or unforeseen events. While history often repeats itself, the market’s reaction can still vary. At the height of the COVID-19 Pandemic, when COVID-related hospitalizations were on the rise, unemployment rates were at an all-time high, and the economy was facing a recession, many investors were bracing for the worst, but the S&P took a surprising upward swing in June 2020, demonstrating just how unpredictable markets can be.3

Data Overload: Dissecting the Noise

AI can process an incredible amount of data, but does it possess the intuition to decipher critical data from the static? Data overload can create too much noise that can lead AI to potentially find false patters or miss critical signals where patterns do exist, called underfitting or overfitting.2  Machines can get bamboozled by noisy markets and can be caught off guard by fickle trends.

The Adaptive Nature of the Market

Markets are constantly moving and changing. They are highly competitive and adaptive.3  For AI to consistently beat the market would require its investing strategy to be equally as adaptive. A caveat for consideration: computers are not intelligently designed to learn and evolve on their own.1  Unlike human beings who have the capacity to evolve, imagine, and generate new thought processes independently, computers currently lack such characteristics.

Regulatory and Ethical Considerations

There are also regulatory and ethical considerations that may prevent AI from performing certain transactions. While the SEC hasn’t completely ruled out AI from investing models, SEC Chair Gary Gensler said the SEC wants to ensure investment advisors and broker dealers are not misleading the public about their use of AI or how they are using it.4 They also need to properly disclose risk involved with using AI and avoid AI washing – making false claims about how AI is being used – that may violate securities laws.4

Human Behavioral Factors

Emotional and psychological factors can play a significant role in an investor’s long-term success. AI investing apps cannot factor in the human dimension of wealth creation that have the power to dramatically influence decisions around money and as a result, the ebb and flow of markets.

Behavioral finance attempts to understand how psychological factors affect markets.  At Matson Money, we are committed to helping families understand both the mathematical and behavioral dimensions of wealth creation. To help families stay disciplined over a lifetime, we train and develop investors through an ongoing relationship with their advisor, who can help them navigate the investors dilemma when it comes to understanding their emotions, biases and instincts around their investing strategy.

Interested in learning how to stay prudent and disciplined over a lifetime? Learn more about Matson Money’s 2-day breakthrough educational event on purpose and investing, the American Dream Experience.

DISCLOSURES:

This content is based on the views, opinions, beliefs, or viewpoints of Matson Money, Inc.  This content is not to be considered investment advice and is not to be relied upon as the basis for entering into any transaction or advisory relationship or making any investment decision.

All of Matson Money’s advisory services are marketed almost exclusively by either Solicitors or Co-Advisors.  Both Co-Advisors and Solicitors are independent contractors, not employees or agents of Matson.

Other financial organizations may analyze investments and take a different approach to investing than that of Matson Money. All investing involves risks and costs. No investment strategy (including asset allocation and diversification strategies) can ensure peace of mind, guarantee profit, or protect against loss.  

PAST PERFORMANCE IS NO GUARANTEE OF FUTURE RESULTS

Efficient Market Hypothesis

Eugene F. Fama, “Random Walks in Stock Market Prices,” Financial Analysts Journal, September/October 1965.

Sources

  1. Zuckerman, Gregory. The Wall Street Journal. Published April 12, 2023. Retrieved 18 January 2024 from https://www.wsj.com/articles/ai-can-write-a-song-but-it-cant-beat-the-market-6df50efd.
  2. What is Overfitting? Amazon. Retrieved 6 May 2024 from https://aws.amazon.com/what-is/overfitting/#:~:text=Underfitting%20vs.,not%20for%20the%20test%20set.
  3. Jennings, John. Why the Stock Market Doesn’t Make Any Sense. Forbes. Published June 15, 2020. Retrieved 6 May 2024 from https://forbes.com/sites/johnjennings/2020/06/15/why-the-stock-market-doesnt-make-any-sense/?sh=79b107fc3eb3.
  4. SEC Chair Gary Gensler on AI Washing. https://www.youtube.com/watch?v=4L_jxkZ9V6U
  5. Artificial intelligence (AI) versus machine learning (ML) versus predictive analytics: Key differences. Tableau. Retrieved 16 May 2024 from https://www.tableau.com/data-insights/ai/AI-ML-predictive-analytics#:~:text=It%20does%20this%20by%20processing,tasks%20from%20mundane%20to%20incredible.
  6. Baldridge, Rebecca and Curry, Benajamin. What is the Efficient Market Hypothesis. Forbes. Published May 11, 2022. Retrieved 16 May 2024 from https://www.forbes.com/advisor/investing/efficient-market-hypothesis/.

Interested in learning more?

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    References to Holdings 

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  • Nobel Prize-Winning Academic Research Disclosure

    www.nobelprize.org 

    The Nobel Memorial Prize in Economic Sciences, commonly referred to as the Nobel Prize in Economics, is an award for outstanding contributions to the field of economics, and generally regarded as the most prestigious award for that field.

    Markowitz, Harry.  “Portfolio Selection.”  Journal of Finance.  1952.

    Harry Max Markowitz is an American economist, and a recipient of the 1989 John von Neumann Theory Prize and the 1990 Nobel Memorial Prize in Economic Sciences. Markowitz is a professor of finance at the Rady School of Management at the University of California, San Diego.

    Efficient Market Hypothesis, first explained by Dr. Eugene Fama in his 1965 doctoral thesis.

    Eugene F. Fama, “Random Walks in Stock Market Prices,” Financial Analysts Journal, September/October 1965.

    Eugene F. Fama, 2013 Nobel laureate in Economic Sciences; is widely recognized as the "father of modern finance." His research is well known in both the academic and investment communities. He is strongly identified with research on markets, particularly the Efficient Market Hypothesis.

    FAMA/FRENCH FIVE FACTOR MODEL 

    Eugene F. Fama, Kenneth R. French, “The Cross-Section of Expected Stock Returns,” Journal of Finance 47, No. 2, (June 1992); Eugene F. Fama, Kenneth R. French, “Common Risk Factors in the Returns on Stocks and Bonds,” Journal of Financial Economics 33, No. 1, (February 1993); Eugene F. Fama, Kenneth R. French, “Profitability, Investment and Average Returns,” Journal of Financial Economics 82, No. 3 (December 2006); Eugene F. Fama, Kenneth R. French, “A Five-Factor Asset Pricing Model,” Journal of Financial Economics 116, No. 1 (April 2015);

    Three Factor Model

    Fama, Eugene F. and Kenneth R. French. “The Cross-Section of Expected Stock Returns,” Journal of Finance, 47, June 1992.

    Efficient Market Hypothesis

    Eugene F. Fama, “Random Walks in Stock Market Prices,” Financial Analysts Journal, September/October 1965.

    Modern Portfolio Theory

    Markowitz, Harry. Portfolio Selection: Efficient Diversification of Investments. New York. Wiley. 1959. Print.

     

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    Specific Risk: Specific risk, also known as nonsystematic risk is unique risk that is local or limited to a particular asset or industry that does not necessarily affect assets outside of that asset class. An example is news that affects a specific stock such as a sudden strike by employees.  Diversification is a key way to help protect yourself from nonsystematic risk. Matson Money clients are invested in securities with broad diversification in an attempt to eliminate nonsystematic risk, however, clients may still be subject to specific risk inside individual asset classes (micro-cap, emerging markets, etc.)

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    Fund of Funds Risk: The investment performance of client portfolios is affected by the investment performance of the underlying funds in which the portfolio is invested. The ability of the total client portfolio to achieve its investment objective depends on the ability of the underlying Matson-advised mutual funds to meet their investment objectives, on Matson’s decisions regarding the allocation of the portfolio’s assets among the underlying Matson-advised mutual funds, and on Matson’s decisions regarding investments made by the underlying Matson-advised mutual funds. The portfolio may allocate assets to an underlying fund or asset class that underperforms other funds or asset classes. There is no assurance that the investment objective of the portfolio or any underlying fund will be achieved. When the portfolio invests in underlying funds, investors are exposed to a proportionate share of the expenses of those underlying funds in addition to the expenses of the portfolio. Matson may receive fees both directly on your account as well as on the money your account invests in the underlying funds, and the underlying funds themselves may bear expenses of the mutual funds or ETFs in which they invest. Through its investments in the underlying funds, the portfolio is subject to the risks of the underlying funds’ investments, with certain underlying fund risks described later in this content. More information on mutual funds, ETFs, and associated fees, is available in fund prospectus documents, available online at: http://funddocs.filepoint.com/matsonmoney/.

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    Market Risk: Even a long-term investment approach cannot guarantee a profit or prevent a loss. Economic, political, and issuer-specific events, known as market risks, will cause the value of fixed income securities to rise or fall.

    Small Company Risk: Securities of small public companies with a total market capitalization (market value) of $300M to $2B are known as small-cap companies. Publicly traded companies with a total market capitalization (market value) of $50M to $300M are known as micro-cap companies.  Both small-cap and micro-cap companies are often less liquid than those of large companies which can make it difficult to sell the securities of small-cap or micro-cap companies at a desired time or price. As a result, small-cap and micro-cap company stocks may fluctuate relatively more in price. In general, these companies are also more vulnerable than larger companies to adverse business or economic developments and they may have more limited resources.

    Value Investment Risk: Value stocks are stocks of publicly traded companies that tend to trade at a “value price” compared to a company’s financials. These stocks may perform differently from the market. Following a value-oriented investment strategy may cause client portfolios to underperform equity investment strategies.

    Risks of Investing in Equities 

    Matson Money utilizes equities in its investment strategies.  These asset categories are held by clients both directly and indirectly, with various sub-categories (large value, small value international, micro-cap, emerging markets, etc.).  Because the value of client investments with Matson will fluctuate, there is risk that you will lose money.  The following is a description of the principal risks of investing in equities, including emerging markets:

    Equity Market Risk: Even a long-term investment approach cannot guarantee a profit or prevent a loss. Economic, market, political, and issuer-specific conditions and events, known as market risks, will cause the value of equity securities, and the investment strategies that own them, to rise or fall which will cause the value of your equity portfolio to rise or fall. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

    Foreign Securities and Currencies Risk: Foreign securities prices may decline or fluctuate because of: (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets. Investors holding these securities are also exposed to foreign currency risk (the possibility that foreign currency will fluctuate in value against the U.S. dollar or that a foreign government will convert, or be forced to convert, its currency to another currency, changing its value against the U.S. dollar).

    Emerging Markets Risk: Numerous emerging market countries have a history of, and continue to experience serious, and potentially continuing, economic and political volatility. Stock markets in many emerging market countries are generally relatively small, expensive to trade in and have higher risks than those in developed markets. Securities in emerging markets also may be less liquid than those in developed markets and foreigners are often limited in their ability to invest in, and withdraw assets from, these markets. Additional restrictions may be imposed under other conditions. Frontier market countries are those that generally have smaller economies or less developed capital markets and, as a result, the risks of investing in emerging market countries are magnified in frontier market countries.

    Small Company Risk: Securities of small public companies with a total market capitalization (market value) of $300M to $2B are known as small-cap companies. Publicly traded companies with a total market capitalization (market value) of $50M to $300M are known as micro-cap companies.  Both small-cap and micro-cap companies are often less liquid than those of large companies which can make it difficult to sell the securities of small-cap or micro-cap companies at a desired time or price. As a result, small-cap and micro-cap company stocks may fluctuate relatively more in price. In general, these companies are also more vulnerable than larger companies to adverse business or economic developments and they may have more limited resources.

    Because of lower daily trading volumes, trading costs for small stocks are higher. Trading costs result from both direct commissions and the price movements caused by buying or selling shares.

    Value Investment Risk: Value stocks are stocks of publicly traded companies that tend to trade at a “value price” compared to a company’s financials. These stocks may perform differently from the market. Following a value-oriented investment strategy may cause client portfolios to underperform equity investment strategies.

    For more information, please see the Matson Money Form ADV Part 2A.

    Risks of Investing in International Equities

    Matson Money utilizes international equities in its investment strategies.  These asset categories are held by clients both directly and indirectly, with various sub-categories (large value, small value international, emerging markets, etc.).  Because the value of client investments with Matson will fluctuate, there is risk that you will lose money.  The following is a description of the principal risks of investing in international equities, including emerging markets:

    Equity Market Risk: Even a long-term investment approach cannot guarantee a profit or prevent a loss. Economic, market, political, and issuer-specific conditions and events, known as market risks, will cause the value of equity securities, and the investment strategies that own them, to rise or fall which will cause the value of your equity portfolio to rise fall. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.

    Foreign Securities and Currencies Risk: Foreign securities prices may decline or fluctuate because of: (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets. Investors holding these securities are also exposed to foreign currency risk (the possibility that foreign currency will fluctuate in value against the U.S. dollar or that a foreign government will convert, or be forced to convert, its currency to another currency, changing its value against the U.S. dollar).

    Emerging Markets Risk: Numerous emerging market countries have a history of, and continue to experience serious, and potentially continuing, economic and political volatility. Stock markets in many emerging market countries are generally relatively small, expensive to trade in and have higher risks than those in developed markets. Securities in emerging markets also may be less liquid than those in developed markets and foreigners are often limited in their ability to invest in, and withdraw assets from, these markets. Additional restrictions may be imposed under other conditions. Frontier market countries generally have smaller economies or less developed capital markets and, as a result, the risks of investing in emerging market countries are magnified in frontier market countries.

    International Small Company Risk: Securities of small public companies with a total market capitalization (market value) of $300M to $2B are known as small-cap companies. Small-cap companies are often less liquid than those of large companies which can make it difficult to sell the securities of small-cap companies at a desired time or price. As a result, small-cap company stocks may fluctuate relatively more in price. In general, these companies are also more vulnerable than larger companies to adverse business or economic developments and they may have more limited resources. Because of lower daily trading volumes, trading costs for small stocks are higher. Trading costs result from both direct commissions and the price movements caused by buying or selling shares.

    International Value Investment Risk: Value stocks are stocks of publicly traded companies that tend to trade at a “value price” compared to a company’s financials. These stocks may perform differently from the market. Following a value-oriented investment strategy may cause client portfolios to underperform equity investment strategies.

    For more information, please see the Matson Money Form ADV Part 2A.

    Risks of Investing in Small/Micro-Cap Stocks

    Matson Money utilizes both Small and Micro-cap asset categories in its investment strategies.  These asset categories are held by clients indirectly through mutual funds, with various sub-categories (large value, small value international, emerging markets, etc.).  Because the value of client investments with Matson will fluctuate, there is risk that you will lose money.  The following is a description of the principal risks of investing in small and microcap securities:

    Equity Market Risk: Even a long-term investment approach cannot guarantee a profit or prevent a loss. Economic, market, political, and issuer-specific conditions and events, known as market risks, will cause the value of equity securities, and the investment strategies that own them, to rise or fall which will cause the value of your equity portfolio to rise or fall. Stock markets tend to move in cycles, with periods of rising prices and periods of falling prices.
    Small Company Risk: Securities of small public companies with a total market capitalization (market value) of $300M to $2B are known as small-cap companies. Publicly traded companies with a total market capitalization (market value) of $50M to $300M are known as micro-cap companies.  Both small-cap and micro-cap companies are often less liquid than those of large companies which can make it difficult to sell the securities of small-cap or micro-cap companies at a desired time or price.  As a result, small-cap and micro-cap company stocks may fluctuate relatively more in price. In general, these companies are also more vulnerable than larger companies to adverse business or economic developments and they may have more limited resources.

    Because of lower daily trading volumes, trading costs for small stocks are higher. Trading costs result from both direct commissions and the price movements caused by buying or selling shares.

    Value Investment Risk: Value stocks are stocks of publicly traded companies that tend to trade at a “value price” compared to a company’s financials. These stocks may perform differently from the market.  Following a value-oriented investment strategy may cause client portfolios to underperform equity investment strategies.

    Liquidity Risk: Generally speaking, small and micro-cap stocks are subject to greater liquidity risk. When liquidity risk is elevated, the security being purchased or sold becomes more expensive than a security that is readily available in the marketplace.

    Volatility Risk: Generally speaking, small and micro-cap stocks are subject to greater volatility risk.  When volatility risk is elevated, the price of a security may fluctuate rapidly in a short period of time.

    Market Uncertainty: Small and micro-cap stocks are subject to market uncertainty. Factors such as geopolitical disturbances, economic fluctuations, politics, international relations, and various business cycles all produce market uncertainty.  Market uncertainly does inform the stock price.

    Risks of Investing in Fixed Income 

    Matson Money utilizes fixed income asset categories in its investment strategies. These asset categories are held by clients indirectly through mutual funds, with various sub-categories (large value, small value international, emerging markets, etc.).  Because the value of client investments with Matson will fluctuate, there is risk that you will lose money.  The following is a description of the principal risks of investing in fixed income cap securities:

    Market Risk: Even a long-term investment approach cannot guarantee a profit. Economic, political, and issuer-specific events will cause the value of fixed income securities owned by Matson portfolios to rise or fall. As a result, the value of your portfolio may rise or fall if it includes fixed income securities.

    Credit Risk: Credit risk is the risk that the issuer of a security may be unable to make interest payments and/or repay principal when due. A downgrade to an issuer’s credit rating or a perceived change in an issuer’s financial strength may affect a security’s value, and thus, impact the investment portfolio’s performance. Government agency obligations have different levels of credit support and, therefore, different degrees of credit risk. Securities issued by agencies and instrumentalities of the U.S. Government are supported by the full faith and credit of the United States, such as the Federal Housing Administration and Ginnie Mae, present credit risk that is generally lower than other securities issued by other state or local agencies, or other public or private entities.  Other securities issued by agencies and instrumentalities sponsored by the U.S. Government, that are supported only by the issuer’s right to borrow from the U.S. Treasury, subject to certain limitations, and securities issued by agencies and instrumentalities sponsored by the U.S. Government that are sponsored by the credit of the issuing agencies, such as Freddie Mac and Fannie Mae, are subject to a greater degree of credit risk. U.S. government agency securities issued or guaranteed by the credit of the agency still involve a risk of non-payment of principal and/or interest.

    Interest Rate Risk: Fixed income securities are subject to interest rate risk because the prices of fixed income securities tend to move in the opposite direction of interest rates. When interest rates rise, fixed income security prices fall. When interest rates fall, fixed income security prices rise. In general, fixed income securities with longer maturities are more sensitive to changes in interest rates.

    Foreign Securities and Currencies: Foreign securities prices may decline or fluctuate because of: (a) economic or political actions of foreign governments, and/or (b) less regulated or liquid securities markets. Investors holding these securities are also exposed to foreign currency risk (the possibility that foreign currency will fluctuate in value against the U.S. dollar or that a foreign government will convert, or be forced to convert, its currency to another currency, changing its value against the U.S. dollar).

    Foreign Government Debt Risk:  The risk that: (a) the governmental entity that controls the repayment of government debt may not be willing or able to repay the principal and/or to pay the interest when it becomes due, due to factors such as political considerations, the relative size of the governmental entity’s debt position in relation to the economy, cash flow problems, insufficient foreign currency reserves, the failure to put in place economic reforms required by the International Monetary Fund or other multilateral agencies, and/or other national economic factors; (b) governments may default on their debt securities, which may require holders of such securities to participate in debt rescheduling; and (c) there is no legal or bankruptcy process by which defaulted government debt may be collected in whole or in part.

    For more information, please see the Matson Money Form ADV Part 2A.

     

  • Index Disclosures

    References to Indices within text

    Investors cannot invest in a market index directly, and the performance of an index does not represent any actual transactions.  The performance of an index does not include the deduction of various fees and expenses which would lower returns. Advisory fees charged to Matson Money clients, whether directly or indirectly through a mutual fund, are described in Matson Money’s Form ADV Part 2A and Form CRS, available at www.matsonmoney.com.

    Data prior to the launch date of the index is hypothetical back-tested data (i.e. calculations of how the index might have performed over that time period had the index existed). There are frequently material differences between hypothetical back-tested performance and actual results. Past performance -- whether actual or back-tested -- is no indication or guarantee of future performance. Hypothetical back-tested performance is used by Matson for educational purposes only and is intended only to demonstrate how the market has historically behaved. Matson does not configure, alter, or otherwise use hypothetical back-tested information in an attempt to artificially enhance or impair performance. Matson only uses hypothetical performance information that is relevant to the financial situation and investment objectives of the recipient as communicated to Matson.

    • S&P 500 Index.

    The S&P 500® Index is widely recognized as representative of the equity market in general.   The S&P 500 Index is an unmanaged, capitalization-weighted index designed to measure the performance of the broad U.S. economy through changes in the aggregate market value of 500 stocks representing all major industries.

     

  • Awards

    Receipt of an award does not acknowledge any particular skill or expertise on behalf of recipient and should not be used in determining whether to enter into any agreement with Matson Money, Inc. Please consider the disclosure of criteria for each award shown.

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