Stock markets have a tendency to rise gradually; In recent times, they have skyrocketed. US stocks have risen 21% since the end of October and are around 5% above their dizzying high in January 2022. On February 22, European equities set a new record for the first time in two years. India is enjoying a multi-year boom and there is optimism about its economy. Even Japanese stocks (synonymous with stagnation) have finally surpassed the level they reached in 1989 before beginning a decades-long decline. It has been an extraordinary streak. Since 2010, the US stock index S
Those gains are even more surprising considering the situations the markets have faced. The era of easy money has been followed by two years of rising interest rates, and even now bond investors are betting against imminent cuts. The United States and China are fighting a trade war; Other real wars are fought in Ukraine, the Middle East and some parts of Africa. Around the world, governments are turning their backs on free markets and globalization in favor of industrial policy and protectionism. If all that hasn't ended the boom, what will?
One conclusion could be that a bubble is about to burst; especially in the United States. On Wall Street, valuations (the multiple by which earnings are calculated) are on average 80% of the level they were during the “dotcom mania” of the late 1990s and 90% of the level reached during 2021, before of interest rates rising at their lowest levels. Similar extreme values are also observed in other parameters, such as concentration (the proportion of the stock market made up of the largest companies) or value spreads (the valuation of the most expensive companies compared to the cheapest).
The value of the top 10% of American companies as a proportion of the entire market has not been this high since the crash of '29, which was one of the causes of the Great Depression in the 1930s. And let's not forget the most effervescent corner of the financial markets: bitcoin is once again trading around $60,000, just below its maximum reached in 2021.
However, there are also reasons to consider the markets' euphoria rational. Coinciding with central banks around the world tightening monetary policy at a pace not seen for a generation, many analysts began to warn of the danger of recessions and declines in corporate profits. In early 2023, Wall Street gurus predicted that the US economy would only grow 0.7% that year. In the end, it more than tripled. A wide range of companies are publishing very positive results; These include retailers, such as Walmart, and Japanese automakers, such as Toyota.
The economy continues to defy gravity. A well-known standard forecast for annualized US economic growth, published by the Federal Reserve Bank of Atlanta, points to 3.2% for the first quarter of this year. Despite the slowdown in China (whose bear markets are an exception to the global trend), the IMF has also been raising its global growth forecasts.
Adding to investors' bullish optimism is their optimism regarding artificial intelligence (AI). This is not a hallucination like those on ChatGPT. The event that launched the shares into the stratosphere was the publication on February 22 of the earnings of Nvidia, which dominates with an iron fist the market for microprocessors essential for training AI models. In October 2022, just before OpenAI launched its now-famous chatbot, Nvidia was making gross quarterly profits of about $3 billion; for the most part, thanks to the sale of graphics cards to gamers. In the three months to the end of January 2024, Nvidia has earned $17 billion in gross profits and enjoyed a 76% margin. In that time, the company's share price has risen fivefold, and its profits have grown even faster. In other words, the enthusiasm that has raised Nvidia to a stock market value close to $2 trillion is not based on dotcom-type hype, but on solid profits.
Now, considering that the boom is justified does not make it prudent to rush out and buy shares. What happens next is unlikely to make investors jubilant. In part, because the enthusiasm for AI extends beyond Nvidia and extends to other members of the Magnificent Seven group of technology stocks, such as Microsoft, whose potential business strategies in the age of AI are far from clear. . These companies are hoarding Nvidia chips, convinced that, one way or another, their AI businesses are going to boom. However, it remains to be seen how they will solve the basic problems of their large language models. There are many startups that want to sink their teeth into the Big Seven business, and competition will keep profits at bay; in the end, even those from Nvidia.
Techno-optimism is also the basis, in some circles, for bullish enthusiasm regarding economy-wide productivity growth. The lesson of other fundamental technologies is that it takes a while to figure out how to exploit them. Companies can't stop talking about it, but generative AI is still in the experimental phase. Consequently, although AI is set to completely transform societies, today's investors may not find it easy to choose the companies that will make money. The believers of the dotcom boom were right about the transformative power of the Internet, but they still lost their shit.
If the level of common sense is maintained this time, valuations will not rise much further. The trend toward increasing profits, as a part of the economy, also seems exhausted. The excessive growth in recent decades has been a one-time phenomenon, caused by the fall in the cost of loans and taxes. Given that inflation persists and public finances remain stressed, this decline cannot be repeated; It can even be reversed.
Based on realistic assumptions about what will happen to valuations, interest and taxes, to generate even a modest real stock return of 4% per year over the next decade, US companies would have to increase their underlying earnings by around 6% annually, close to its best post-war performance. No wonder Warren Buffett, a veteran investor, sees “no chance” of super returns for his fund.
Equities can disappoint in many ways. Perhaps AI euphoria will cause a dot-com bubble to burst. Another war or another crisis could lead to a crash. Or perhaps prices stagnate, leading to a slow bear market that takes years to reverse. Whatever the path to disappointment, ten years from now no one will repeat today's obvious conclusion: that equity investors (especially Americans) have enjoyed a golden age.
