About 100 years ago, electricity began to sweep across the developed world, changing lives and sending stock prices soaring. You don’t have to be an economic historian to know that the Great Depression of the 1930s resulted in part from the unbridled risk-taking of the roaring 20s.
Today, it is again difficult to find signs of investor restraint. All told, US stock prices are roughly 45% above the top of what I consider their fair value trading range. I’d consider the stock overvalued even if we knew for certain that artificial intelligence — the likely cause of recent investor enthusiasm — would ultimately transform every aspect of human life, bringing economic benefits on par with the advent of electricity.
In the U.S. technology and communications services sector, stock prices are inexplicably high relative to expected corporate earnings growth rates. Since ChatGPT went public on November 30, 2022, the average share price in both sectors has nearly doubled.
The technology’s potential to drive productivity and profits clearly justifies some level of share price premium. But as a group, large-cap tech companies in the S&P 500 have recently been anywhere from 80% more expensive than the rest of the market (in terms of their price-to-trailing earnings ratios) to more than four times as expensive (price-to-sales).
Overvaluations are not limited to one or two sectors. Incredibly expensive AI-related stocks combined with bullish pricing in most other market segments make the overall US stock market more overvalued than at any time since early 2001. My estimate is based on proprietary Vanguard a measure of fair valuation that puts stock prices in the context of decades worth of corporate earnings, as well as prevailing levels of interest rates and inflation.
While there are no good tools for timing the market, estimates are notoriously bad. The market tends to swing from periods of overvaluation to periods of undervaluation while spending relatively modest periods in the area of ​​fair value.
Indeed, Vanguard research on megatrends reveals that large overvaluations and corrections tend to coincide with transformative technological changes. Investors get euphoric early on and then experience disappointment when the vast potential of a new technology isn’t realized more quickly.
Consider the late 90s. Some of today’s biggest companies were small caps back then. They would grow into power plants, and the Internet would transform the economy. And yet the broad US stock market still suffered a nearly 50% decline in the 30-month tech, media and telecommunications crash that began in March 2000. Tech stocks suffered much more.
I am optimistic about the future of artificial intelligence. There is a significant chance that it will spur significant gains in productivity and economic growth over the next decade or so. But we are not yet in the AI ​​boom. For the promise of artificial intelligence to be fully realized, the low adoption rates of artificial intelligence must rise, and companies must learn how they can take advantage of the technology. At Vanguard, we don’t expect the peak effects of artificial intelligence on productivity and economic growth before the 2030s.
Meanwhile, earnings growth expectations for the next three to five years are extremely optimistic.
Individual companies’ revenues and profit margins can surprise dramatically up or down, but overall, the two components of corporate profits tend to be slower moving and more predictable. They will almost certainly disappoint in the near-medium term.
Even if AI ultimately transforms the economy, as the Vanguard Megatrends Model suggests it will, the companies that will benefit the most will be outside the technology sector. In my estimation, the productivity gains across all industries would be as if the 17 million baby boomers expected to retire between now and 2034 never did.
Indeed, if AI proves transformative, every company on the planet will benefit—not just those in Silicon Valley.
More must-read comments posted by him Wealth:
Opinions expressed in Fortune.com comments are solely the views of their authors and do not necessarily reflect the opinions and beliefs Wealth.
