The golden age of the stock market is coming to an end

These gains are even more surprising when you consider what conditions the market has had to contend with. After the free money era, he has had two years of rising interest rates, and bond investors are still betting on an impending rate cut. The trade war between the US and China is intensifying. Actual wars are occurring in Ukraine, the Middle East, and parts of Africa. Governments around the world are turning away from free markets and globalization in favor of industrial policy and protectionism. Even if this rise doesn’t stop, what happens?

One conclusion may be that we are waiting for a bubble to burst, especially in the United States. On Wall Street, valuations (the multiple by which earnings grow) are on average 80% higher, the same as they were during the dot-com mania of the late 1990s, and 90% higher in 2021, before interest rates hit rock bottom. Interest rates have risen. Similar extremes are seen in other metrics such as concentration (the share held by the top companies in the stock market) and value spread (the valuation of the most expensive companies compared to the cheapest) . The value of the top 10% of American companies in the overall market has not been this high since the crash of the 1930s, which he was one of the causes of the Great Depression. And don’t forget about the frothy corners of financial markets. Bitcoin is once again trading around $60,000, just shy of its 2021 peak.

But there are also reasons to think the market boom 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 risk of economic recession and declining corporate profits. In early 2023, Wall Street pundits predicted that the U.S. economy would grow by just 0.7% next year. The event achieved more than three times that amount. A wide range of companies have reported strong results, including retailers such as Walmart and Japanese automakers such as Toyota.

The economy continues to defy gravity. The general forecast (annual rate) of the US economic growth rate published by the Atlanta Federal Reserve is 3.2% for the first quarter of this year. Despite the weakness in the Chinese market, the IMF has also been gradually raising its global growth forecast, even though the market weakness is an exception to the global trend.

Investors’ bullishness is fueled by their optimism about artificial intelligence (AI). This is not an illusion like Chatgpt. The event that sent the stock into the stratosphere was the Feb. 22 earnings announcement by Nvidia, which holds an iron grip on the market for chips essential to training AI models. In October 2022, just before OpenAI released its now-famous chatbot, Nvidia was generating roughly $3 billion in gross profit per quarter, most of it from selling graphics cards to gamers. was. In his three months to the end of January 2024, Nvidia earned $17 billion in gross profit while enjoying his 76% margin. The company’s stock price has increased fivefold in that time, but its revenue has grown even faster. In other words, the frenzy that has brought NVIDIA stock near his $2 trillion mark is built not on dot-com-style hype, but on cold, hard profits.

However, it would be unwise to rush into buying stocks assuming the boom is justified. Investors are unlikely to be overjoyed about what happens next. Part of the reason is that the extreme excitement about AI extends beyond his Nvidia to other members of the “epic 7-inch” group of tech stocks, such as Microsoft. Microsoft’s final commercial strategy for his AI era is not yet clear. These companies are stocking up on his Nvidia chips. Either way, you believe your AI business is going to boom, but you still don’t know how to solve fundamental problems with large-scale language models, and you want to eat the Big 7’s lunch. Therefore, competition will continue. Profits will be suppressed and in the end he will also benefit from Nvidia.

In some regions, technology optimism is also the basis for bullishness about economy-wide productivity growth. The lesson from other fundamental technologies is that it takes time to figure out how to leverage them. There’s a lot of talk about generative AI in the enterprise, but it’s still in the experimental stage. As a result, today’s investors may have a hard time choosing which companies will make money, even if AI is destined to fundamentally change society. The believers of the dot-com boom weren’t wrong about the transformative power of the Internet, but they still lost their shirts.

If this time remains healthy, valuations will not rise any further. Spending also appears to be progressing, as the share of profits in the economy is on the rise. The company’s significant growth in recent decades has been temporary, driven by lower borrowing costs and taxes. That decline cannot be repeated as inflation lingers and government finances remain tight. Sometimes it’s the other way around.

Under realistic assumptions about what valuations, interest rates, and taxes will be, U.S. companies would need to increase their underlying earnings by about 6% per year to generate a modest real stock return of 4% per year over the next 10 years. There is. Best performance since the war. It’s no wonder that veteran investor Warren Buffett thinks there’s “no chance” of super returns for his funds.

long and difficult road

The stock market can be overwhelmed in many ways. Perhaps AI euphoria will cause a dot-com-style bubble. A new war or crisis could lead to a crash. Alternatively, prices could stagnate in a mild bear market and take years to reverse. Whatever the path to disappointment, in 10 years no one will repeat today’s obvious conclusion that stock investors, especially US stock investors, were enjoying a golden age.

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