J Studios/DigitalVision via Getty Images"The essence of strategy is choosing what not to do." – Michael PorterEngland experienced a period of strong prosperity in the late seventeenth century. The economy thrived due to good harvests, strong foreign trade, and the influx of Dutch and Huguenot immigrants, who brought capital and skills. Easier credit emerged through a market in merchants' bills of exchange. Trading companies prospered, posting high returns that fueled speculative interest in London's stock market. This led to the rise of 'projectors', individuals who promoted schemes or projects that aimed to deliver public benefit while also generating private profit. In 1686, Captain Phips formed a company to salvage treasure from sunken vessels. He subsequently located the wreck of the Nuestra Señora in the Bahamas and recovered over 17,000 kilograms of treasure, which enabled him to pay his investors a 10,000% return on their investment.1 The golden age of "projectors" had begun.Although some projectors made meaningful contributions to economic development, the term increasingly carried a negative connotation, associated with fraudulent schemes. During the Nine Years' War with France in 1688, England prohibited French imports, which disrupted England's trade with the rest of the world. English merchants, compelled to find alternative uses for their capital, invested in the burgeoning stock market, fueling a boom in domestic joint-stock companies. Many of these companies had been established to produce goods formerly supplied by France, such as glass, textiles, and paper. By 1695, there were over 140 joint-stock companies, 80% of which had been established in the previous seven years. Some of the companies promoted during the boom were based on serious ideas, but the majority were little more than fraudulent attempts by 'projectors' to exploit what was fashionable.Projectors, as satirized in the third book of Jonathan Swift's Gulliver's Travels , published in 1706, typically floated companies with patents for inventions, but these 'inventions' were usually not of a practical nature. Examples included a teacher training the blind to distinguish paint colors by touch and smell, or the innovator training hogs to plow fields by burying food for them to root out. The possession of a patent meant little: they were easily obtained and said little about an invention's scientific worth. They became little more than marketing gimmicks, which is why genuine inventors, concerned with secrecy, avoided them. Projectors represented opportunists who capitalized on the public's excitement for innovation without delivering real value. In Gulliver's Travels , Swift warned about blind faith in technological progress and exposed the greed surrounding intellectual property and speculative business practices of his time. His satire remains relevant today as it highlights the timeless dangers of speculative inventions and untrustworthy promoters across history.That blind faith in technological progress has resurfaced in today's stock market, with extraordinary gains driven by the boom in artificial intelligence (AI), much like the internet bubble of the late nineties. However, today's AI euphoria occurs during a period when financial markets carry levels of debt significantly larger than they were twenty-five years ago. According to the International Monetary Fund (IMF), total global debt, including government, corporate, and household debt, was $64 trillion in 2000. The Institute of International Finance estimates that total global debt now stands at $338 trillion, 528% greater than it was twenty-five years ago.2 Global stock market capitalization reached its peak of $44 trillion in March 2000, before the bubble burst. As of September 2025, global stock market capitalization is $132 trillion, 300% larger than the peak of the Internet Bubble.3 Stock market capitalization in the United States reached $14.8 trillion in December 1999 but now stands at $66.7 trillion, with only half the number of U.S. public companies listed today as there were twenty-five years ago. Today, more capital is being allocated to fewer companies.Market structure has also evolved since 2000. It is easier for investors to buy stocks through passive vehicles, such as exchange-traded funds (ETFs), a form of equity ownership that eliminates the need for fundamental analysis. Unlike in 2000, investors can now easily trade stocks without incurring brokerage commissions, and they can also trade from anywhere on their mobile phones. The genesis of passive investing can be traced to the academic research of Bill Sharpe, a Nobel Prize-winning economist and professor emeritus at Stanford University. The Capital Asset Pricing Model (CAPM), developed by Sharpe in 1964, describes the relationship between systematic risk, otherwise known as 'beta', and expected returns on assets. This model supports the efficient market hypothesis, implying that in "well-functioning markets," it is difficult to consistently outperform the market after accounting for risk. Therefore, when stock prices fully reflect all information, investors should hold the market portfolio.Niche passive investment products emerged in the early 1970s. Still, they gained mainstream popularity with the launch of the Vanguard 500 in 1976 by Jack Bogle, making a passive market capitalization– weighted product accessible to retail investors. "Passive investing" refers to market capitalization-weighted index strategies that replicate the performance of a broad market index or benchmark. Today, passive products dominate investor portfolios, but this dominance carries unintended consequences. The growth of passive index products, driven by low fees, simplicity, broad access to diversification, and strong performance, has changed market behavior. The trillions of dollars invested in market capitalization–weighted products have increased stock co-movement within the same index, reduced diversification, and weakened price discovery. Passive products are indifferent to fundamental information, such as sales growth, operating margins, or a company's position within its industry. Passive investment strategies allocate assets solely based on market price and recent momentum.Passive investing now dominates the allocation of investment capital. Many academics believe that the passive share is far higher because many institutional investors are "closet indexers." In contrast, actively managed strategies have experienced persistent net redemptions. According to an ETF Global Insights report, global ETF net inflows reached nearly $2 trillion in 2024, while investors withdrew a record $450 billion from actively managed funds, surpassing the previous year's outflow of $413 billion.4 The scale and persistence of this divergence underscore the shift in market structure.While passive ETFs allow investors to acquire diversified portfolios at low cost, the trend towards passive inflows carries unintended consequences. Unless markets are perfectly efficient (and they are not), passive flows sustain momentum-driven misvaluation because they are indifferent to fundamental information. Regular contributions to IRAs and defined-contribution retirement plans mechanically allocate those savings into passive products. These valuation-indifferent fund flows amplify any such misvaluation—expensively valued stocks only grow more expensive. Fund flows into passive strategies effectively crowd out active investors who allocate capital based on fundamental information. Stocks from distinctively different sectors are increasingly moving in tandem.As passive products dominate, they form a single, coordinated trade, increasing market vulnerability and volatility. Stocks with higher passive ETF ownership exhibit greater exposure to market shocks, making them more vulnerable during downturns when liquidity disappears. This dynamic creates more fragile market conditions, such as when President Trump announced "Liberation Day" on April 2nd. U.S. stocks dropped by 4.9% on April 3, the first full trading day after the announcement. Fortunately for the value investor, who allocates his capital based on fundamentals, this structural fragility is an opportunity to capitalize on market inefficiencies. Mechanical investment fund inflows distort asset prices, creating investable opportunities before prices revert to their fundamental values. Although fleeting in recent years, patient investors who focus on fundamentals can exploit these mechanical price inefficiencies.During the dot-com internet bubble, market capitalization-weighted indices grossly overweighted stocks within the overvalued technology sector, resulting in devastating index returns when the bubble burst. In contrast, fundamentally driven value investment strategies performed far better over the market's full cycle. The concern today is that massive fiscal and monetary stimulus over the last three decades has inflated not only stocks but also bonds, real estate, collectibles, and private equity. Every asset denominated in a paper-based currency rose sharply in value. The S&P 500 ((SP500), (SPX)) is currently valued at 31 times annual reported earnings, compared to its historical average multiple of 16 times. Because valuation multiples far exceed the average earnings growth rate of even the most successful companies, current stock prices for many companies will likely prove unsustainable. While the term "bubble" is a matter of one's opinion, any asset that trades at prices far exceeding the asset's ability to generate sufficient income to support its current valuation is a start. Sustaining a bubble requires valuation multiples to outpace profits in perpetuity.After several decades of unprecedented growth, aided by massive fiscal and monetary tailwinds, private equity or buyout firms now face a new reality. Attractively valued takeover targets are scarce, financing costs have increased, and private equity companies are struggling to liquidate their aging portfolio investments. These new headwinds have slowed fund distributions so dramatically that, at the current rate, it will take a decade for investors to receive their initial investment from the more than 12,000 companies held by US buyout funds.5 A decade of near-zero interest rates and easy financing enabled private equity firms to acquire businesses, restructure the acquired companies' capital structure, and then sell them at inflated valuations. Once the U.S. Federal Reserve began increasing interest rates in 2022, the industry struggled to exit portfolio investments acquired at valuations that no longer matched realistic profit expectations.While sophisticated institutions dominate the flow of funds into private equity, retail investors drive the endless flow of funds chasing anything related to artificial intelligence, which in turn is powering the S&P 500 Index to new daily record highs. Just six companies (NVIDIA, Microsoft (MSFT), Apple (AAPL), Alphabet ((GOOG) (GOOGL)), Amazon (AMZN), and Meta (META)), with a combined market value exceeding $19 trillion, account for more than a third of the entire value of the S&P 500. With only a handful of companies accounting for most of the S&P 500's market capitalization and performance, there is a significant but unseen risk in the market. As one analyst on Substack recently noted, underpinning such extreme valuation is the stock market's projected belief that these companies hold a significant technological edge over global competition.6The most valuable and arguably the most important of these six leading companies is chip designer NVIDIA, whose advanced semiconductors form the basis of the United States' dominance in AI. Access to the best semiconductors provides other U.S. technology companies a competitive advantage over international competitors, which in turn drives their combined market value ever higher. Importantly, NVIDIA does not produce its own semiconductors—it designs them but outsources the manufacturing to Taiwan Semiconductor Manufacturing (TSM) Company (TSMC), the global leader in semiconductor foundry services. In turn, crucial to TSMC's business is its access to ASML (ASML) Holding's lithography machines, which are used to etch the ultra-fine features needed for modern processors. NVIDIA's (NVDA) designs, TSMC's manufacturing expertise, and ASML's advanced lithography machines form the foundation of the current stock market boom.Considering what China has done to almost every other industry it has competed against [solar photovoltaics, lithium-ion batteries, electric vehicles, wind turbines, rare earth elements, steel production, shipbuilding, high-speed rail equipment, nuclear power, 5G telecommunications equipment], few contemplate what happens when China directly competes with the U.S. in the field of artificial intelligence. Wall Street is quick to project that China is not yet technologically advanced enough to compete in AI, but that has been said about every Western industry China has disrupted over the past twenty-five years. Today's extreme valuation premium assigned to U.S. technology companies is predicated on sustaining current revenue growth rates and operating profit margins. If competition with Chinese firms erodes those fundamental metrics, then today's stock prices will prove transitory.Regardless of the looming competition from Chinese companies, other concerns exist. The Massachusetts Institute of Technology published a report in July that reviewed 300 implementations of AI across 52 organizations. It concluded: "Despite $30 to 40 billion in enterprise investment into GenAI, this report uncovers a surprising result in that 95% of organizations are getting zero return.... The core barrier to scaling is not infrastructure, regulation, or talent. It is learning. Most GenAI systems do not retain feedback, adapt to context, or improve over time."7 The report highlights several significant concerns, particularly considering that Microsoft allocates 47% of its budgeted capital expenditure to Nvidia semiconductor chips. Additionally, Meta allocates 25%, Alphabet allocates 16%, Tesla (TSLA) allocates 13%, Amazon allocates 11%, and Apple is set to allocate 8%. The budget of these six companies combined represents 43% of Nvidia's revenue.8 With a market value exceeding $4.5 trillion, comprising 8% of the S&P 500 Index, the hopes and dreams of many retail investors depend on Nvidia's continued outperformance.Regardless of the industry, a value investor focuses on fundamentals such as cash flow generated from a company's operations and the company's ability to generate returns on its invested capital. From a capital cycle perspective, this means considering capital flows, industry structures, and potential returns on investment. According to estimates from Morgan Stanley (MS), the cumulative investment in data centers is expected to reach $3 trillion by 2028, excluding the cost of energy. Meanwhile, McKinsey Consulting forecasts that number to reach $5.2 trillion by 2030. The stock market clearly projects that this will be a wise investment. Since the release of ChatGPT in 2022, the six leading technology companies in the United States (NVDA, MSFT, AAPL, AMZN, META, GOOG) have increased their combined market value by $11.8 trillion.McKinsey estimates that 60% of data center AI investment will be allocated to semiconductor chips and hardware, which are currently depreciated over 5.5 years. If these assets generate no economic profit beyond that brief period and assume that Morgan Stanley $3 trillion capital investment is heavily backend loaded, then just the semiconductor chips and hardware investment alone would need to generate a net cash flow of over $500 billion in 2028 to meet the cost of capital on just the equipment investment. If data center operators need to generate a 20% free cash flow margin to justify their share prices, that implies a revenue requirement of $2.5 trillion. Suppose customers of data centers also need to maintain a similar profit margin. In that case, consumers and businesses will need to pay about $3.1 trillion for AI services, equivalent to 10% of the current US economic output.9Just as with the internet, the demand for AI will continue to grow exponentially, but the required revenue to justify today's capital investment is substantial. For perspective, Netflix (NFLX) generated approximately $39 billion in revenue in 2024 with roughly 300 million subscribers, while Microsoft Office 365 reached $95 billion in revenue. OpenAI has the largest user base for its AI chatbot andcurrently generates an annual revenue of $13 billion. No one questions AI's importance and future growth potential, but investors need to understand the fundamental limitation of AI in generating sufficient revenue to cover its current capital expenses. Despite fundamental pushback on the current AI capital cycle, many Wall Street strategists shockingly believe markets are entering the early stages of a new economic cycle. The S&P 500 has returned 23.6% per year since the March 2020 low, yet Wall Street sees a new bull market in stocks. A recent memo from market commentator and respected bond investor Howard Marks provides a plausible explanation for today's relentless optimism:"Investors are by nature optimistic. You must be an optimist to hand over your money to someone else in the hope of getting more back later. This is especially true of equity investors, and I think their optimism dies hard. When they're in an optimistic mood, investors have the ability to interpret ambiguous developments positively and overlook negatives. The last sustained market correction ended in early 2009, meaning it's been over 16 years since risk-bearing was seriously punished and "buying the dips" wasn't rewarded. That means no one under 35 or so – professional and amateur investors alike – has ever experienced a prolonged bear market. Older investors have experienced one or more, but, with the passage of such a long time, some may have been lulled into a false sense of security." 10Data from the Natixis Global Survey for individual investors reveals a significant disconnect between investors' return expectations and the risk they are willing to take. Overall, 83% describe themselves as either conservative or moderate investors, yet they still expect to generate investment returns of 10.7% above inflation over the long term.11 This means that investors need to be comfortable holding stocks indefinitely at the highest valuation levels in U.S. market history, while expecting still higher valuations. Based on history, current fundamentals, and realistic assumptions, today's market price levels imply long-term returns that are less than half of current expectations. In early 2000, an investor might have looked back on the spectacular returns of the S&P 500 over the previous eighteen years, averaging nearly 20% annually, and imagined that those returns could be extrapolated into the future. A similar gap in expectations exists today.Speculative excesses, reminiscent of the "projectors" of the 17th century, once again prevail in today's AI-driven market euphoria. Fueled by faith in technological progress, soaring levels of global debt, an unstoppable stock market, and the dominance of passive investing via ETFs, today's "projectors" ignore the value investor's cautionary warnings. If "the essence of strategy is choosing what not to do," then the prudent investor chooses to sidestep the speculative allure of companies like Nvidia. Yet his or her investment goal remains the same—to deploy client capital using rigorous fundamental analysis while employing a sufficient margin of safety….. not speculation.With kind regards,ST. JAMES INVESTMENT COMPANYFootnotes1 David Harding and James Holmes, "The Pit & Pendulum: A Menagerie of Speculative Follies," Winton Capital, 2012.2 Global debt hits record of nearly $338 trillion, says IIF3 https://focus.world-exchanges.org/issue/september-2025/dashboard4 ETFGI reports the global ETFs industry gathered a record 1.88 trillion US dollars during 20245 Sarah Holder, "Private Equity Faces a Reckoning," Bloomberg, September 22, 2025.6 "Trump Card," Doomberg, September 23, 2025.7 Aditya Challapally et al., "The GenAI Divide," MIT NANDA, July 2025, Page 3.8 Laura Bratton, "Big Tech Spending Drove Nvidia's Rise," Yahoo Finance, May 24, 2025.9 Marathon Global Investment Review, Volume 39 Number 6, September 30, 2025.10 The Calculus of Value11 2025 Individual Investor Survey: Welcome to the age of diminished expectations | Natixis Investment ManagersST. JAMES INVESTMENT COMPANYWe founded the St. James Investment Company in 1999, managing wealth from our family and friends in the hamlet of St. James. We are privileged that our neighbors and friends have trusted us to invest alongside our capital for twenty years.The St. James Investment Company is an independent, fee-only, SECregistered investment Advisory firm that provides customized portfolio management to individuals, retirement plans, and private companies.DISCLAIMERInformation contained herein has been obtained from reliable sources but is not necessarily complete, and accuracy is not guaranteed. Any securities mentioned in this issue should not be construed as investment or trading recommendations specifically for you. You must consult your advisor for investment or trading advice. St. James Investment Company and one or more affiliated persons may have positions in the securities or sectors recommended in this newsletter. They may, therefore, have a conflict of interest in making the recommendation herein. Registration as an Investment Advisor does not imply a certain level of skill or training.To our clients: please notify us if your financial situation, investment objectives, or risk tolerance changes. All clients receive a statement from their respective custodian on, at minimum, a quarterly basis. If you are not receiving statements from your custodian, please notify us. As a client of St. James, you may request a copy of our ADV Part 2A ("The Brochure") and Form CRS. A copy of this material is also available on our website at www.stjic.com. Additionally, you may access publicly available information about St. James through the Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov. If you have any questions, please contact us at 214-484-7250 or info@stjic.com.Original PostEditor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.