The Debate on US Equity Markets: Bubble or Not?

There is ongoing debate among investors about whether the US equity markets are currently in a bubble, reminiscent of the 1999/2000 internet bubble, but this time with a focus on artificial intelligence (AI). If a market bubble exists, a significant market downturn could have widespread repercussions on global asset allocation and financial markets.

Historical Context

• After the bubble burst in March 2000, the Nasdaq plunged by 78% and the S&P 500 by 49% over a 30-month period.
• The Nasdaq required 15 years to surpass its year 2000 peak of 5,000.

Indicators of a Bubble

• The Shiller cyclically adjusted price-to-earnings (CAPE) ratio is at about 40 times, historically indicative of bubble territories.
• Market concentration is at an all-time high, with the top 10 stocks accounting for nearly 40% of the S&P 500 index.
• There are nine US companies with market capitalizations exceeding $1 trillion, three of which have annual profits of around $100 billion.
• The market is bifurcated with average stock performance lagging behind major indices, similar to patterns seen during the 1998–99 period.

AI and Capital Expenditure

• Massive capital expenditure on AI is noted, with four major companies planning to spend $320 billion on technology capital in 2025.
• This spending represents 10% of India’s GDP, but the return on this investment remains uncertain.

Corporate America and Economic Concerns

• Corporate profit margins are near all-time highs, with concerns of over-earning relative to nominal GDP.
• The US fiscal deficit stands at 7% of GDP, with a debt-to-GDP ratio of 100%.

The Bear Case

• High valuations and massive capex with unclear returns suggest potential overvaluation.
• The US economy is perceived to be running above trend, with fiscal discipline deteriorating.

The Bull Case

• Valuations are driven by mega-cap stocks, with the top 10 companies trading at higher earnings multiples compared to the rest.
• AI investment is seen as a driver of sustained productivity, potentially boosting GDP and earnings growth.
• The US benefits from energy security, technology leadership, and favorable demographics, arguing for a premium valuation.
• Current market conditions do not mirror the rampant speculation of the late 1990s.

Conclusion and Personal View

The author remains skeptical of the bull arguments and suggests that a gradual derating of US assets is preferable to a sharp market correction. They emphasize caution, hoping the US is not in a bubble, as a burst could lead to drastic global market impacts.