SUMMARY
The AI-led market surge has aroused bubble concerns. But given the robust profits and absence of leveraged capex, we do not see this situation as a speculative frenzy.
KEY TAKEAWAYS:
AI capital expenditure is largely self-funded, not driven by leverage
High S&P 500 valuations are backed by record profits
Unprofitable tech names are still vulnerable
Third-quarter earnings are critical for sustaining market momentum
Is AI the new dot.com?
Skyrocketing stock prices. Bold predictions about a tech-driven future. Massive infrastructure buildouts.
If this all feels familiar, you’re not alone.
Clients are increasingly asking us: “Are we in another tech bubble?”
It’s a fair question – especially for those who remember the pain of the dot-com bust in 2000.
Back then, speculative mania drove valuations far beyond fundamentals. When the bubble burst, it triggered a deep bear market and a multi-year recovery for even the strongest tech names.
Today’s AI-driven rally may look similar, but we believe the fundamentals tell a different story.
Why AI growth looks more sustainable
Unlike the dot-com era, today’s tech giants aren’t borrowing to fund innovation. They’re reinvesting robust profits into AI infrastructure like data centers, chips, and cloud platforms.
This reinvestment cycle is driven by cash flow, not credit. That is why we see the AI buildout as sustainable, not speculative.
High valuations, supported by earnings
Next, consider valuations. Admittedly, the S&P 500 Index – home to many of the world’s leading AI and tech-adjacent firms – isn’t cheap.
On forward earnings, the S&P’s current rating is above where it has been for 95% of the time over the last 15 years.
That said, we would argue that this elevated valuation is supported by fundamentals.
Net profit margins are at or near record highs, having risen largely alongside valuations over this period.
Put simply, US listed large-cap companies are more profitable than ever. Current market pricing largely reflects these strong underlying fundamentals rather than pure speculation.
AI capital expenditures are likely to broaden
Looking ahead, potential rate cuts could reduce borrowing costs and encourage broader AI investment beyond the mega-cap names.
Our case is that AI-driven capital expenditure is poised to broaden and accelerate in the quarters ahead. We think this represents a sustainable investment trend rather than fleeting enthusiasm.
Where risks still linger
Not all tech stocks are created equal.
We continue to take a measured view on unprofitable growth names – especially those with sky-high valuations but weak or nonexistent free cash flow.
Such companies remain highly sensitive to rate surprises or any signs of slowing growth like what we saw in 2022.
What to watch this earnings season
With over 50% of S&P companies reporting this month, this is a pivotal earnings season.
Around 60% of year-to-date gains have been driven by earnings, so continued profit strength is essential for further upside.
We are closely monitoring three key themes during this reporting season.
The first is whether companies can show returns on their AI investments. There are some concerns that their spending has been largely circular, e.g., AI firms investing in the same cloud providers that are funding them.
Next is the state of corporate outlooks amid economic data gaps. With government data delays due to shutdowns, company guidance will be critical in gauging real-time demand, pricing power, and macro health.
Third are multinationals’ insights into global trade dynamics and supply chain costs. These may help shape profit margin expectations.
Our market outlook: Not a bubble, but the bar is high
In our view, this is not a classic speculative bubble driven by cheap credit or hype. Rather, it’s a rally grounded in real earnings, disciplined reinvestment, and accelerating innovation.
That said, expectations and market sensitivity are high. For this rally to continue, earnings must deliver.
