There is little data to suggest that a stock market correction is imminent, despite warnings of a potential bubble in AI stocks, says Albemarle Street Partners.
Against a backdrop of market uncertainty and fears of an AI-fuelled bubble, the firm has published a report ‘AI and Markets – Towards the Event Horizon.’
The report acknowledges that valuations across equity markets are elevated in general and ‘on the surface, the extraordinary AI share price growth looks exactly like a bubble’.
However, the report points out that there are some important differences surrounding AI stocks, the most important being that whilst valuations are high, the profits produced by leading companies have kept up with their price rises in a way that is different to previous bubbles.
According to Goldman Sachs strategists Peter Oppenheimer and Sharon Bell: “While stock prices have appreciated strongly up until now, these have been associated with powerful and sustained profit growth rather than excessive speculation about the future.”
This is at odds with typical bubbles, which are related to speculation about profits that may occur in the future, not growth already being achieved.
Indeed, the tech-heavy Nasdaq index has actually seen valuations fall, not rise, over the past five years.
“The fact that overall valuations across the technology sector have not risen is also due to the fact that the market is rationally calculating the downsides of AI. These companies that mostly sell software have seen their share prices fall sharply over the last year on fears that their subscription based models will break,” the report said.
With stock market valuations at a high level generally, Albermarle said it could mean a correction to bring valuations back in line is on the horizon but called this a “normal and self-healing process in stock markets” and one that investors are generally well-advised to look through.
The report said: “Over a ten-year period, it generally pays to own cheaper rather than more expensive shares, but over any time periods shorter than that, the correlation between the price you pay and the return on shares is very low indeed.
“In short, the data does not tell us that share prices like this are particularly associated with a correction this year, next year or in five years with any certainty. Those investors who sell, hoping to avoid one, are in our view just as likely to miss a period of prolonged positive returns as to protect their investments.”
Importantly, Albemarle said the evidence does not suggest the current market can be characterised as a bubble in AI stocks. However, that is not to say a future bubble is inconceivable, the firm said.
“Old adages tell us to stay invested through the ups and downs of the stock market cycle. There is much to be said for this. We believe that following market trends and riding out the short-term corrections invariably rewards investors in the long term. We do not believe that an overall portfolio strategy should be changed because valuations have become stretched, and a correction could temporarily interrupt markets. This is especially true during a period of falling interest rates, which render such a correction a possibility but by no means a certainty.
“However, bubble risk must be understood differently. Bubbles can damage investor outcomes for the long term, and so our vigilance around valuation risk in areas like technology stocks remains constant. On balance, we do not see clear evidence of a bubble yet, but if that evidence builds, we can and will act decisively to introduce resilience to portfolios.”
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