The golden age of stock markets is coming to an end

Stock markets rise slowly; They have skyrocketed recently. U.S. stocks have risen 21% since the end of October and are about 5% above their peak in January 2022. On February 22, European stocks hit a new record for the first time in two years. India has been enjoying a boom for several years as there is optimism about its economy. Even Japanese stocks – synonymous with stagnation – have finally surpassed levels reached in 1989, before decades of decline. It has been an extraordinary career. Since 2010, The S&P 500 index of US stocks has returned 11% annually in real terms.

These gains are even more surprising considering what the market has had to deal with. Interest rates kept rising for two years following the era of free money, and even now bond investors are betting against an imminent cut. There is a trade war between United States and China, There are real wars that rage Ukraine, the Middle East and parts of Africa, Around the world, governments are turning away from free markets and globalization in favor of industrial policies and protectionism. If all this does not end this protest, then who will?

One conclusion might be that a bubble is ready to burst, especially in the United States. on wall street, valuations (the multiple by which earnings have grown) are on average 80% higher than during the dotcom mania of the late 1990s and 90% higher than they were during 2021, before interest bottomed out. Is. Rates increased. Similar extremes are seen in other measures, including concentration (the proportion of the stock market composed of the largest companies) or value dispersion (the valuation of the most expensive companies compared to the cheapest). The value of the top 10% of US companies as a proportion of the total market has not been this high since the crisis that was one of the causes of the Depression of the 1930s. And let’s not forget the frothiest corner of the financial markets: Bitcoin is once again trading around $60,000, just below its 2021 maximum.

However, there are reasons to believe the market rally is rational. As central banks around the world tighten monetary policy at a pace not seen in a generation, many analysts have warned of the threat of a recession and a decline in corporate profits. By early 2023, experts wall Street He predicted that the US economy would grow only 0.7% next year. If you receive more than three times that amount. A wide range of companies are reporting good results, including retailers like Walmart and Japanese automakers like Toyota.

The economy continues to defy gravity. A common and popular forecast of annual economic growth in the United States, published by the Bank of atlanta federal reserve, for the first quarter of this year is 3.2%. Despite the slowdown in China (whose declining markets are an exception to the global trend), International Monetary Fund It is also raising its global growth forecasts.

Adding to investors’ optimism is their optimism about artificial intelligence (AI). This is not some kind of hallucination chatgpt, The event that pushed the stock into the stratosphere was the Feb. 22 earnings release from Nvidia, which has a strong hold on the market for chips that are crucial for training artificial intelligence models. In October 2022, just before OpenAI launched its now-famous chatbot, Nvidia made about $3 billion in gross profit each quarter, mostly from selling graphics cards to gamers. In the three months to the end of January 2024, Nvidia made $17 billion in gross profit and enjoyed 76% margins. During that period, the company’s share price increased five times, but its profits increased even faster. In other words, the excitement that led to this NVIDIA Their near-$2 trillion stock market value is not based on dot-com hype, but on cold, hard profits.

However, deciding that the bullishness is justified does not mean that it is wise to rush out and buy the stock. Investors are unlikely to be happy with what happens next. This is partly because the immense enthusiasm for AI extends beyond Nvidia to other members of the “Magnificent 7” group of tech stocks, such as Microsoft, whose ultimate business strategies in the AI ​​era are still some way from being clear. . These companies are stockpiling Nvidia chips with the belief that, somehow, their AI business will prosper. However, it remains to be seen how they will solve the fundamental problems with their larger language models. Many startups want to eat the Big 7’s lunch, and competition will keep profits in check, which ultimately includes Nvidia.

He techno-optimism It is also, in some sectors, the basis for optimism about productivity growth in the economy. The lesson from other foundational technologies is that it takes time to understand how to exploit them. Companies talk about generative AI all the time, but it’s still in the experimental stage. As a result, even if AI is set to completely transform society, today’s investors may find it difficult to choose which companies will make money. Believers in the dot-com boom weren’t wrong about the transformative power of the Internet, but they were shirtless nonetheless.

If the situation remains good this time, the valuation will not go up much. The trend of increasing profits as a percentage of the economy also seems to be ending. Its huge growth in recent decades was extraordinary, driven by falling borrowing costs and taxes. Since inflation persists and public finances are under pressure, this decline may not be repeated; This can also be reversed.

Under realistic assumptions about what will happen to valuations, interest and taxes, to generate nominal real stock returns of 4% per year over the next decade, US companies would need to grow their underlying earnings by about 6% per year , which is close to their estimate. Best performance in post-war history. It’s no wonder that veteran investor Warren Buffett sees “no chance” of big returns for his fund.

This stock can disappoint in many ways. Perhaps the enthusiasm for AI will cause the dot-com bubble to burst. Another war or crisis could lead to collapse. Or prices may stagnate in a mild bear market that will take years to reverse. Whatever the path of disappointment, ten years from now no one will repeat today’s obvious conclusion: Stock investors – especially American investors – have enjoyed a golden age.

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