What to Make of the Bullish AI Market

Approaching the end of Q2 2024, the economy and stock market are holding steady and surprisingly strong. Most economists through Q1 and Q2 2023 forecasted a surefire recession for the U.S. economy, however, this looming threat was eliminated by the AI-fueled stock market rally taking charge in late 2023. The U.S. economy carried this strong financial finish through Q1 and Q2 of 2024. The Dow, S&P 500, and Nasdaq are up double-digit points YTD and talks of a recession have been stopped amid slowing inflation and continued bullish investing. 

The stock market surge can largely be attributed to the incredible success of tech stocks throughout 2024, most notably the “Magnificent 7”, a collection of juggernaut stocks that have been significantly outperforming the rest of the market.

Amazon, Apple, Google, Meta, Microsoft, Nvidia, and Tesla have been crowned the “Magnificent 7”. They have been a key factor in the U.S.’s uniquely strong post-pandemic financial recovery.

 In 2023, the Magnificent 7 climbed 75.71%, while the rest of the S&P 500 accounted for only 24.23% growth. As of June 2024, the Mag 7 alone makes up 31.5% of the S&P 500. While the industry leaders have slowed down from their massive jump, now the entire tech industry is booming thanks to AI. 

Understanding the AI-fueled Market

All 7 members of the “Magnificent 7” have big money and plans for work in the AI space. Artificial Intelligence is a money-making machine in 2024, investors, venture capitalists, and media are all over it. 

Nvidia’s success in AI advancements skyrocketed the company to a $3.22 trillion market cap and +200% market growth (Wang 2024). Microsoft’s stock also surged to record highs after the company partnered with OpenAI, the company responsible for creating ChatGPT. Most recently, Apple’s stock surged 7% to a record high immediately following the announcement of their take on the AI game, Apple Intelligence (Schafer 2024). 

Although still slightly top-heavy, the rest of the tech market too has joined the trend. Almost a quarter of all venture capitalist funding has gone exclusively to AI-based startups, while non-AI is a failing business plan. (Steven 2024)

However, the long-term financial success of AI is to be seen, investor confidence is still the driver of the stock-market surge as companies navigate the early stages of AI advancement. Investors are betting on companies like Apple and Microsoft to deliver big on their announcements. So, while the AI-fueled market has given strength to the U.S. economy, will this prove to be another economic bubble that bursts once the frenzy is all said and done?

The Dot.com Bubble 

An economic bubble occurs when asset prices rapidly escalate beyond the asset’s actual value, usually caused by a sudden, drastic change in investor behavior. All bubbles eventually “burst”, resulting in the rapid deflation of said asset’s value. (Kenton 2022) According to MarketWatch, the rallying stock market shows some characteristics of an investment bubble. Economists suspect that “equities in the U.S. will keep outperforming those in the rest of the world as a bubble fueled by enthusiasm about AI inflates” (Wang 2024). The excitement surrounding AI is allowing stocks like the Magnificent 7 to disproportionately succeed in the U.S. stock market. In this way, the AI “bubble” is very reminiscent of the Dotcom bubble before it (1995-2000).

The Dotcom bubble was an investment frenzy following the launch of the World Wide Web in 1989. There was rampant overinvestment and, more importantly, overvaluation of new internet companies. When valuing companies, investment analysts overlooked important factors such as revenue generation, P/E ratio, and growth expectations in favor of finding companies with high website traffic and usage rates. 

Consequently, many companies were significantly overvalued; overconfident investors then went all in, demonstrated by a 1200% boom of the NASDAQ from 1995-2000. The bubble burst in 2002 when the venture capitalists who funded many startup companies began to bail when their investments fell short of the sky-high expectations. A 75% dip in the NASDAQ followed, essentially reversing the entire boom and cementing the Dot.com bubble in financial history. (CFI)

Some elements of the modern-day market are very reminiscent of the infamous Dot.com bubble. Specifically, investor behavior is following a similar pattern in overwhelmingly favoring AI startup companies. The question to ask is whether these factors will bring about the end of another market boom, or if the market is strong enough to prevail.  

Is History Repeating? 

When comparing the state of the present-day market to that of the Dot.com bubble, there does seem to be cause for concern when considering the similarities such as investor behavior, rapid growth, and disproportionate success of the industry leaders. However, investment data suggests that investors are smarter in 2024, and may avoid the mistakes made a quarter century before them. 

Firstly, when comparing the change in stock prices, the modern AI leaders had a growth of 200% in the last 5 years (2019-2024) while the NASDAQ increased by 1200% in that same time frame during the Dot.com bubble (1995-2000). The former tech leaders (Microsoft, Cisco, Intel, Lucent, IBM), as well as the rest of the tech market, had highly unrealistic success to replicate in the long term. The boom we are seeing today is far less drastic, a more favorable figure for sustainability. (Sota 2024)

The tech industry leaders of 2000 were also lacking in two key investment metrics: earnings per share (EPS) growth and price/earnings (PE) ratio. EPS is a company’s net income divided by the number of outstanding shares; it is the primary measure of profitability. The P/E ratio is the stock price divided by EPS, a measurement of how much each dollar of earnings costs. (Sota 2024)

Both are popular valuation metrics used by investors; the tech leaders of the Dot.com bubble had an EPS growth of 30%, 12% shy of the 2024 AI leaders sitting at 42%. These companies also had an inflated P/E ratio of 59x, compared to the 34x ratio of the 2024 leaders. Thus, the stock market leaders of 2024 are expected to grow 12% more than the leaders of 2000 and will see lower valuations due to the lower P/E ratios. Modern tech leaders are expected to grow at a higher rate and earn profit at a cheaper price, significantly undervalued compared to their 24-year-old counterparts. In hindsight, it is much safer to invest in today’s market than it was in 2000. (Sota 2024)

The investment data largely suggests that the AI-fueled market rally is here to stay going strong. Investors are betting on companies with promising growth expectations and established plans for further work in the AI space, which is a much more sustainable approach than the trigger-happy spending of the Dot.com bubble. 

Tech industry leaders are paving the way for the future of AI, and startups are finding massive success following in their footsteps. AI is in a very early stage, but it has already proven to be a reliable revenue generator that companies plan to build more upon.

Considering the positive investment metrics and the proven commitment of companies to developing AI, there is a lot to be optimistic about as an investor in 2024. 

Works Cited

Wager, Steven. "Venture Capital’s AI Love Affair: A Bubble Waiting to Pop?" The Hill, 22 Mar. 2024, https://thehill.com/opinion/4732242-venture-capitals-ai-love-affair-a-bubble-waiting-to-pop/. 

"How to Invest in AI’s Next Phase." J.P. Morgan, 2024, https://www.jpmorgan.com/insights/investing/investment-trends/how-to-invest-in-ais-next-phase.

Moffatt, Mike. "Comparing P/E, EPS, and Earnings Yield." Investopedia, 5 Dec. 2013, https://www.investopedia.com/articles/investing/120513/comparing-pe-eps-and-earnings-yield.asp.

"Bubble." Investopedia, https://www.investopedia.com/terms/b/bubble.asp#:~:text=Typically%2C%20a%20bubble%20is%20created,the%20fundamentals%20of%20the%20asset.

Hilton, Nick. "Is AI a Bubble?" Medium, 18 Oct. 2021, https://nickfthilton.medium.com/is-ai-a-bubble-7befb5067091.

"Dotcom Bubble." Corporate Finance Institute, https://corporatefinanceinstitute.com/resources/career-map/sell-side/capital-markets/dotcom-bubble/.

Wang, Isabel "The AI Bubble Has Helped the U.S. Stock Market Dominate the World—What Happens If It Bursts?" MarketWatch, 1 July 2024, https://www.marketwatch.com/story/the-ai-bubble-has-helped-the-u-s-stock-market-dominate-the-world-what-happens-if-it-bursts-9d5c9359?mod=article_inline.

"Apple Stock Surges to Record High After AI Announcements." Yahoo Finance, 4 July 2024, https://finance.yahoo.com/news/apple-stock-surges-to-record-high-after-ai-announcements-150325922.html.