William Edwards
4 min read
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AI stocks have surged since November 2022, with Nvidia up 761% and Palantir more than 600%.
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But some experts warn of high valuations and potential overestimation of AI's economic impact.
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Geopolitical risks, like China-Taiwan tensions, could also disrupt the AI supply chain.
Since November 2022, artificial intelligence stocks have been the place to be in the market.
Nvidia is up 761% over that time. Palantir is up 604%. Taiwan Semiconductor has returned 165%. And Microsoft is up 88%. It's been a gold rush.
But how long can the AI trade last? Some experts, like Morgan Stanley's Head of Global Research Katy Huberty, have said that we're still in the early innings of the technology and robust returns still lie ahead.
Few seem to refute the idea that AI will transform the US economy to some degree and be an eventual boon for profits. But some have urged caution about investing in the theme after such a huge run of outperformance. Irrational exuberance and greed are running rampant, they worry, potentially setting AI stocks up for a spectacular bust somewhere down the line.
While the outlook on the technology's role in the economy is bullish, there are some threats to AI's dominance in the stock market. Five of them are detailed below.
Generally speaking, AI stocks are expensive with their prices relative to their earnings over the last 12 months at elevated levels.
For example, the iShares Future AI & Tech ETF (ARTY) has an average trailing 12 months PE ratio of 35.2, and the The Technology Select Sector SPDR Fund (XLK) is trading at 36.7 times earnings. Nvidia trades at a 45 PE ratio. By comparison, the S&P 500, which is at historically expensive levels, has a 23.7 PE.
While AI stocks may have stronger growth prospects than those in other industries, high valuations mean those prospects are already priced in. If actual earnings performance underwhelms compared to expectation, then the stocks could start to underperform.
High valuations tend to weigh on long-term performance. For example, Microsoft traded at 72-times trailing earnings in 2000. While it went on to lead the way in internet technology, it didn't recover its 2000 highs until 2016.
AI may make tasks more efficient, but perhaps not to the degree the market thinks, said Jim Covello, head of Global Equity Research at Goldman Sachs, in a June 2024 report.
"People generally substantially overestimate what the technology is capable of today. In our experience, even basic summarization tasks often yield illegible and nonsensical results," Covello wrote.
