It's time for the tech earnings season, which sparks discussions about the future of artificial intelligence (AI) and the potential financial gains for companies and investors in the coming years and decades ahead. This leads to nicknames like the "Magnificent Seven, " a term popularized last year to refer to the megacap tech giants: Nvidia Corp. , Apple Inc. , Microsoft Corp. , Tesla Inc. , Meta Platforms Inc. , and the Google parent company Alphabet Inc. However, it's crucial to remain cautious about the expectations that can sometimes become disconnected from reality. Rob Arnott, the founder of quant-focused Research Affiliates and a pioneer in smart beta, warns investors to beware of falling victim to the "big market delusion. " Arnott explains that this term, coined by professors Brad Cornell and Aswath Damadoran, describes a scenario in which a substantial new market emerges around an innovation. In a 2019 paper exploring this phenomenon, Cornell and Damadoran examined how this "big market promise" affects the formation and financing of businesses. They found that entrepreneur and financier overconfidence leads to an overvaluation of companies operating in alleged big markets. Arnott, who subsequently co-wrote a paper with Cornell investigating the phenomenon in the electric vehicle context, adds that the delusion assumes that the dominant players in the early stages of a new market will remain dominant and that the transformation promised by the innovation will happen rapidly. To illustrate his point, Arnott recalls the tech bubble in the early 2000s when Qualcomm Inc. shares surged significantly.

However, the promised growth didn't materialize as expected, and it took 18 years for investors to see positive returns. Arnott emphasizes that the same narrative is now being spun around AI. While AI is likely to be transformative, akin to the internet, the belief that it will happen rapidly and that today's dominant players will maintain their dominance in the future is flawed. He highlights the example of the Palm Pilot, which initially had a higher market cap than General Motors but was eventually overtaken by BlackBerry and later by the Apple iPhone. Arnott cautions that big disruptors often face disruption themselves. So, how can investors overcome their delusions about the current players in the AI landscape?Arnott suggests a smarter approach would be to identify industries that are likely to benefit the most from AI's productivity boost and analyze whether consolidation within those industries can lead to greater profit margins. Historically, technological revolutions tend to benefit customers and users more than the innovators themselves. In conclusion, being hyped about the so-called Magnificent Seven companies poised to benefit from AI windfalls may require a reality check. As Arnott aptly notes, in the 1960 Western film that inspired their nickname, four of the seven main characters do not survive.