Singapore Expat Advisory

Is AI Driving a Stock Market Bubble?

The traditional definition of a bull market is a 20% rise in a benchmark index, like the S&P500. The ongoing love affair between investors and AI related stocks has pushed the market up by 20% since October 2022’s low. So, technically, we are in a new bull market. In reality, its somewhat more nuanced.

This is because, even by the standard of recent years, the stock market is unusually weighted towards a handful of high-flying technology stocks. Almost all the gains in the market can be attributed to fewer than 10 companies, such as Nvidia, Google and Microsoft.

Nvidia is the star performer of this select group and the latest addition to the “Trillion Dollar Company Club”. The excitement among investors that AI will transform the economy has led to Nvidia trading around 200 times expected earnings, 4 times higher than 1 year ago. Nvidia has returned 198% YTD!

Many would think that no rational investor would invest in a company valued at 200 times earnings. Unfortunately, not all investors are rational and if you need proof Google – Zoom Video Communications highest P/E ratio.

The exponential rise in this select group of outperforming stocks are already drawing comparisons with the Dot Com Bubble of the 1990’s. This was when markets were pushed higher by a very narrow sub-set of companies. Of course, whilst this period lasted, many investors made fortunes but as with all bubbles it ended badly.

The rest of the market is following a more sideways trajectory and has been for the last year or so. Performance is firmly split between tech stocks and the rest. Any suggestion, that the new bull market means everything is tickety boo again may be over optimistic.

The 20% definition of a bull market is a blunt instrument and only makes sense if the gains are achieved across the board. Savvy investors will be looking for that market breadth before they are convinced. Investors will also be eyeing whether corporate earnings are on an upward trend and if the interest cycle is poised to change direction.

Why Could This Drive a Bubble?

Many professional investors were beginning to lower their position on Nvidia and the other tech stocks. However, there is now a lot of retail money heading into these stocks. The professionals now must ask themselves – should we get back on board?

Unfortunately, if they don’t, the returns on their funds risk looking sub-standard comparatively to market returns. A fund manager’s return in comparison to the market is often how they are judged. This is precisely why fund managers, particularly in the US, find it so difficult to keep pace with market returns when the market is driven by such a small cross section of companies. If they’re not in those large, influential companies, they stand no chance of matching the market.

So, retail interest grows, professional investors get back in – this is how stock market bubbles can inflate.

Artificial intelligence is a transformative technology. It sits in a long line of transformative technologies, railways, radio, the internet. It’s tempting to get sucked into something that may change the world without thinking too hard what you’re paying for that opportunity.

 

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Singapore Expat Advisory is an agency for Promiseland Pte. Ltd and are authorised and regulated by the Monetary Authority of Singapore (MAS).
General Information Only This article should not be construed as an offer, solicitation of an offer, or a recommendation to transact in any products (including funds, stocks) mentioned herein. The information does not take into account the specific investment objectives, financial situation or particular needs of any person. Advice should be sought from a licensed financial adviser regarding the suitability of the investment. This article has not been reviewed by the MAS

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