Are We in Another Investment Bubble? Lessons from History and the AI Hype
About a century ago, the world was electrified—literally. The advent of electricity revolutionized daily life and sparked a surge in stock prices. But the euphoria of the Roaring ‘20s, fueled by unrestrained risk-taking, eventually led to the Great Depression of the 1930s. Fast forward to today, and it seems history might be repeating itself, albeit with a modern twist. This time, the buzzword isn’t electricity—it’s artificial intelligence (AI).
The AI Frenzy: A Stock Market Surge
Since the public launch of ChatGPT on November 30, 2022, the U.S. stock market has been riding a wave of AI-driven enthusiasm. In particular, the technology and communication services sectors have seen their average stock prices nearly double. Investors are betting big on AI’s potential to transform industries, drive productivity, and unlock unprecedented economic growth. But is this optimism justified, or are we heading toward another bubble?
According to Vanguard’s proprietary fair-valuation measure, U.S. stock prices are currently about 45% above the top of their fair-value trading range. This overvaluation is not limited to tech stocks; it spans most market segments, making the overall U.S. stock market more overvalued than at any point since early 2001. For context, the late 1990s saw a similar pattern during the dot-com boom, which ended in a dramatic market crash.
Overvaluation in Numbers
Let’s break down the numbers. Large-cap tech companies in the S&P 500 Index are currently trading at a premium that’s hard to justify. Their price-to-trailing earnings ratios are 80% higher than the rest of the market, and their price-to-sales ratios are more than four times as expensive. While it’s true that transformative technologies like AI can drive productivity and profits, the current valuations seem to be running far ahead of reality.
Vanguard’s research highlights a historical trend: periods of extreme overvaluation often coincide with the early stages of transformative technological changes. Investors become euphoric, only to face disappointment when the technology’s potential takes longer to materialize than expected. This pattern was evident during the dot-com bubble, when the U.S. stock market suffered a near-50% decline between 2000 and 2002, with tech shares taking the hardest hit.
The Long Road to AI’s Full Potential
Despite the current hype, Vanguard’s chief economist remains cautiously optimistic about AI’s future. The firm’s Megatrends Model suggests that AI could drive significant gains in productivity and economic growth over the next decade. However, the peak effects of AI are not expected until the 2030s. For now, adoption rates remain low, and companies are still figuring out how to harness the technology effectively.
In the short to medium term, earnings growth expectations for AI-related companies appear wildly optimistic. Corporate profits, which are driven by revenues and profit margins, tend to be slower-moving and more predictable in the aggregate. This means that the lofty expectations for AI-driven growth are likely to disappoint in the near term.
Beyond Silicon Valley: AI’s Broader Impact
One of the most intriguing aspects of AI is its potential to benefit industries far beyond the technology sector. Vanguard’s analysis suggests that the productivity unlocked by AI could be equivalent to keeping 17 million baby boomers—who are expected to retire by 2034—in the workforce. In other words, AI’s transformative power could ripple across every industry, not just those based in Silicon Valley.
For investors, this means that the biggest beneficiaries of AI might not be the tech giants dominating today’s headlines. Instead, companies in sectors like healthcare, manufacturing, and logistics could see significant gains as they adopt AI to streamline operations and boost efficiency.
Lessons from the Past
History offers valuable lessons for today’s investors. The late 1990s were a time of rapid technological innovation, with the rise of the Internet and the emergence of companies that would later become household names. Yet, despite the transformative potential of these technologies, the stock market experienced a severe correction when expectations outpaced reality.
Similarly, the current AI-driven market surge could be setting the stage for a future correction. While it’s tempting to get caught up in the excitement, investors should approach the market with caution and a long-term perspective.
Key Takeaways for Investors
- Valuations Matter: The U.S. stock market is currently overvalued, with tech stocks trading at significant premiums. Investors should be wary of paying too much for growth that may take years to materialize.
- AI’s Potential is Real, But Long-Term: While AI has the potential to transform industries and drive economic growth, its full impact is unlikely to be felt until the 2030s.
- Diversify Beyond Tech: The benefits of AI will extend far beyond the technology sector. Investors should consider opportunities in other industries that stand to gain from AI adoption.
- Learn from History: The dot-com bubble serves as a cautionary tale about the dangers of overvaluation and unrealistic expectations.
Conclusion: A Time for Caution
The current wave of AI-driven market enthusiasm is reminiscent of past periods of technological euphoria. While the potential of AI is undeniable, investors should be mindful of the risks associated with overvaluation and overly optimistic growth expectations. By taking a measured approach and focusing on long-term fundamentals, investors can navigate the opportunities and challenges of this transformative era.
Originally Written by: Vanguard
