Can Artificial Intelligence (AI) be used to identify mispriced stocks?

Active investors have long pursued an informational advantage in the markets by using AI to collect and analyze data.

For example, tools that gauge sentiment from social media or scrape text from company financial reports predate ChatGPT by many years.

AI-generated information is likely just a small part of the extensive knowledge available in the market, which is reflected in market prices.

If new information is obtained, the process of acting on that information incorporates it into market prices.

Another reason to question AI’s role in helping with market timing is limitations with its predictions.

More specifically, AI’s forecasting ability performs well when evaluating patterns that are fairly stable.

But the market isn't stable... it's fantastically complex.

So much so that no one knows exactly how much a specific piece of information affects a price, as there are numerous other simultaneous factors.

AI predicting market prices is like...

... forecasting the weather if clouds could consciously decide when and where to rain.

... or like playing chess on a board where pieces randomly swap rules mid-game.

As an example, consider the AI-Powered Equity ETF (Ticker: AIEQ), launched in 2017.

It employs IBM Watson’s AI to analyze publicly available information to pick US stocks that will outperform the US market.

Sounds enticing! 🤗

Here is how it has worked out:

While Watson may outsmart a single person, its intelligence is insignificant compared to the collective knowledge of the millions of people participating in markets each day.

It is perhaps unsurprising then that the Watson-powered ETF has lagged the broad US market and, by a wide margin, the US technology sector since its inception.

Sure, AI can help the execution of trades.

But the market is powerful and ensures a price is the most accurate current representation of the value of a stock or bond.

While AI might not be able to identify mispriced stocks and outperform the market, it can enhance an investment manager's process.

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