The AI Bubble: Are Valuations Getting Out of Hand?
Count Torsten Sløk, chief economist at Apollo Global Management (NYSE:APO) as a skeptic of the artificial intelligence (AI) hype behind much of the recent stock market rally.
In a note published over the weekend titled “The Current AI Bubble is Bigger than the 1990s Tech Bubble,” Sløk writes that the top 10 companies in the S&P 500 today have a higher forward price-to-earnings (P/E) ratio than the top 10 companies had in the mid-1990s during the tech bubble.
Valuation Concerns
A forward price-to-earnings ratio is a valuation metric that divides the current share price by the estimated next year’s earnings per share. A lower ratio means that a stock is cheaper, all else being equal. The median forward P/E ratio of the top 10 companies in the S&P today is around 40, while in 2000, at the peak of the tech bubble, the same metric was relatively much lower at only about 25.
It’s not the first time Apollo Global’s leading economist flagged valuation concerns among the market’s largest companies. In a note published on Jan. 9, Apollo pointed out that the market cap of the Magnificent Seven equaled the size of the Japanese, Canadian, and U.K. markets combined.
Risk and Concentration
Just because a company has a high forward price-to-earnings ratio does not mean it will live up to its growth expectations. It’s just that investors are leaving less margin of safety for any possible growth disappointments. Extra risk market concentration brings more risk if one or more of these high flyers cannot live up to its growth targets.
The SPDR S&P 500 ETF Trust (NYSE:SPY) tracks the S&P 500 index, a market cap-weighted index of large- and mid-cap U.S. stocks. The top 10 holdings of the SPDR ETF account for over 31% of its total assets, leaving passive index investors potentially more exposed to concentration risk than they might realize.
Looking Ahead
Whether or not the AI bubble bursts or lives up to its high expectations is a question investors will have to tackle in the years to come. However, for those skeptical of valuations or market concentration, it might pay to remember the lessons from economist John Maynard Keynes, who shared that markets can stay irrational for longer than an investor can stay solvent.
Investors who have ridden the AI wave up have been rewarded. The S&P 500, led by its big tech components, is already up over 7% year to date. Meanwhile, small-cap exchange-traded funds (ETFs) without the major AI players, such as the Vanguard Small-Cap Index Fund ETF (NYSE:VB), have lagged, gaining just over 2% year to date.
As the market continues to evolve, it’s essential for investors to pay attention to valuation metrics, industry trends, and concentration risks to make informed decisions about their portfolios.
This article Apollo’s Chief Economist Sounds Alarm On AI Bubble, Warning It’s ‘Bigger Than The 1990s Tech Bubble’ originally appeared on Benzinga.com
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