The stock market has seen remarkable growth in recent years. The S&P 500 index has surged about 57% in just the past two years. It has more than doubled in the past five years.
This impressive growth has led some to reevaluate their financial positions. They are considering splurging on luxury items or expensive properties. But is this growth sustainable?
Or is it a bubble waiting to burst? One reader recently expressed concerns. “The market seems to be in a huge bubble right now due to all sorts of hype around Artificial Intelligence.
Does this make it more vulnerable to a huge crash in the future? Will it affect my retirement?”
To understand the current situation, it’s essential to revisit the fundamentals of what a stock represents. A stock is essentially a piece of ownership in a company.
It’s similar to owning a rental house where you collect rent. The value of the stock should ideally reflect the future earnings or profits that the company is expected to generate. However, the current market scenario shows a significant disparity between stock prices and the actual earnings of companies.
For example, if you had invested $100,000 in the S&P 500 in 2019 and reinvested the dividends, your investment would now be worth $256,960. That’s a 157% gain. Yet, the earnings from that investment would have increased by only 42%.
This indicates a sharp rise in the Price-to-Earnings (P/E) ratio. This means investors are paying more for each dollar of earnings. Interestingly, this growth is not evenly distributed across the market.
Ai-driven market concerns rise
The recent surge has been driven mostly by the seven largest tech companies. They are Apple, Nvidia, Microsoft, Amazon, Google, Facebook, and Tesla.
They are collectively dubbed the “Magnificent Seven.” These companies alone account for over 25% of the entire market value. They have significantly higher P/E ratios compared to the rest of the market. The excitement around these companies is largely fueled by advances in Artificial Intelligence (AI).
Recent AI developments have opened up possibilities across various fields. These range from software development to autonomous vehicles and healthcare. They are driving investor optimism.
Companies are investing heavily in AI infrastructure. They aim to capitalize on these advancements. AI’s potential to revolutionize productivity and efficiency is indeed impressive.
For instance, AI can analyze vast amounts of data. It can drive innovation in drug development. It can even manage complex tasks like coding and legal analysis.
The vision of an infinite, highly intelligent AI workforce is compelling. But it also raises questions about future earnings, potential cost overruns, competition, and social impacts like unemployment. While the promise of AI is driving the market, it’s important to note that predicting the future is inherently uncertain.
Historically, US economic growth has averaged about 3% after inflation. This is despite dramatic changes in technology and the economy over the decades. In conclusion, the current stock market exuberance is largely fueled by optimism around technological advancements, particularly AI.
While the potential for growth is significant, investors should remain cautious of the risks and uncertainties that come with such rapid changes and high valuations.
