Rise of the Machines

In a 2003 science fiction movie Rise of the Machines a malevolent, self-aware artificial intelligence (AI) system unleashes a human looking robot programmed to seek out and eliminate human holdouts stopping it from gaining total control. To prevent extinction humans have to figure out how to outsmart the machines. Twenty-two years later, AI is no longer science fiction. Hopefully our true life AI story ends on a more positive note than the movie.

In today's real world the machines are coming for your portfolio. Their strategy is similar to one used by social media. They capture your online tracking data then use AI to feed you custom tailored content designed to influence you to take a targeted action. While social media uses customized advertising to influence your spending decisions, some brokerage firms could potentially use customized content to influence your investment decisions. To be more specific, inducing more frequent trading might increase a firm's profits. The danger lies in the potential for machines to prioritize a firm's profits over yours. For example, consider an action filed by the Massachusetts Secretary of State in 2020 alleging a firm's app-based service used strategies that treated trading like a game to lure young, inexperienced customers into placing risky trades. The case was settled in 2024 when the firm paid $7.5 million which it said resolves historical matters no longer reflective of the firm.

Are the machines winning? The rise of readily available online trading applications seems to have fueled, or at least paralleled, what appears to be a significant increase in the number of trades by individual investors. While there is no definitive way to demonstrate this theory, there is a lot of circumstantial evidence. In June 2020, the Financial Industry Regulatory Authority (FINRA) released a paper entitled, "Report on AI in the Securities Industry". Buried in the report is a line that tells us a number of broker-dealers use AI to, "analyze their customers’ investing behaviors, website and mobile app footprints, and past inquiries, and in turn, to proactively provide customized content to them". Then in November 2024 the Chicago Board Options Exchange (CBOE) posted an article entitled, "Growth of U.S. Equities Volume and Rise of Retail". My interpretation is it infers there has been an approximate doubling of individual (retail) investor trading activity since the 2020 report by FINRA on AI. You need to read these publicly available reports for full details and context.

So why does any of this matter? Institutional investors (big pools of money) tend to review financial reports that detail a company's profitability. They understand a fundamental market tenet that long-term market up trends are driven by long-term aggregate increases in company profits. On the other hand, individual investors are more likely to react to news of a company's latest product development or new customer contract. Thanks to the rise of the machines, markets have become more influenced by individuals. As a consequence stock prices are now more sensitive to news and less sensitive to a company's capacity to grow profits. Sooner or later the market tenet will prevail and investors will refocus on companies' profits. Do the companies you own make more news than profits?

Frank Rizzo,  CERTIFIED FINANCIAL PLANNER ^TM

The opinions in this material are for general information only and not intended to provide specific advice or recommendations for any individual. The economics and market forecasts set forth in this material may or may not develop as predicted and there can be no guarantee that strategies promoted will be successful. Investing includes risk, including fluctuating prices and loss of principal.