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AI optimism is driving the S&P 500 price-to-book ratio to records, surpassing dot-com levels.
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High valuations reflect expectations for AI-driven earnings.
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While the ratio's level is head-turning, it doesn't necessitate that stocks are in a bubble.
Stock-market bulls convinced of the power of AI to transform the economy often shrug off comparisons to the dot-com bubble a quarter century ago. The real profits are already showing up, unlike in the early days of the internet boom — so it is different this time, the thinking goes.
But Bank of America strategist Michael Hartnett has a message for these investors: “It better be different this time.”
Hartnett, who has often expressed skepticism of the market's bull run over the last few years, shared a head-turning chart that highlights just how optimistic investors have become about the impact AI will have. It shows the S&P 500's price-to-book ratio, which measures the total market cap of the index's constituents compared to their total assets minus liabilities.
The valuation measure is at a record high of 5.3, topping the 5.1 level seen in March 2000, at the peak of the dot-com bubble.
Other classic valuation measures show market froth relative to history. For instance, Hartnett also shared a chart showing the S&P 500's 12-month forward price-to-earnings ratio. Except for August 2020, it's at the highest level since the dot-com era.
And the Shiller cyclically-adjusted price-to-earnings ratio, which measures current prices against a 10-year rolling average of earnings, is at similar levels to 1929, 2000, and 2021.
High valuations reflect high expectations for future earnings. Sometimes those expectations turn out to be too elevated, and prices correct, but they don't necessitate a bubble scenario. So far, many AI firms have continually beat earnings expectations, suggesting the optimism could be justified.
Valuations are also better predictors of average long-term returns than near-term performance, and views on Wall Street on where the market goes in the months ahead differ. Though there are calls for caution, many strategists continue to raise their year-end S&P 500 price targets.
Earlier this week, Rick Rieder, the chief investment officer of global fixed income at BlackRock, said the market is in the “best investing environment ever” thanks to factors like strong demand for stocks, looming rate cuts, and recent boosts in productivity and earnings growth.
If the market does start to unwind, however, Hartnett said he sees bonds and non-US stocks benefiting. Examples of funds that offer exposure to these trades include the iShares Core U.S. Aggregate Bond ETF (AGG) and the Vanguard FTSE All-World ex-US ETF (VEU).
Read the original article on Business Insider
