Tech earnings do little to settle the debate over whether AI stocks are overvalued.
- Investors are divided on whether billion-dollar investments can translate into profits
- Bubbles can go on for much longer than investors think
- The only real solution for investors is to diversify
This is an important week for big tech companies, with Alphabet, Microsoft, Meta, Apple and Amazon reporting earnings. However, investors hoping for an answer to the big market question of the day – are AI stocks in a bubble? – may be disappointed. Investors remain stubbornly divided on whether they can translate their billion-dollar investments into profits. The bubble is in the eye of the beholder.
Certainly, there are bubbly characteristics to the current market. The dominance of big tech has been a feature of markets for more than a decade. Valuations are high and markets have become increasingly concentrated on a handful of names. On the other hand, it is possible to argue that AI is a major revolution, we are only in the foothills of its development, and it has far further to run. This week’s earnings haven’t settled this debate.
Anthony Rayner, fund manager on the Premier Miton macro thematic multi-asset team, says this is a question they are being asked a lot by clients at the moment. “Understandably so, with many equity markets at, or close to, record highs. Talk of lofty asset prices inevitably brings us back to AI, where there is a high level of newsflow, although not necessarily high levels of visibility. We would argue that if it looks like a bubble and smells like a bubble, then it probably is.”
However, he also points out that bubbles can go on for much longer than investors think: “It doesn’t pay to be too pre-emptive, even if today’s market has all the hallmarks of a bubble.” Even if investors conclude there are bubble characteristics to the current market, selling out wholesale is likely to be the wrong option.
Tom Rizzo, portfolio manager of T. Rowe Price’s Global Technology Equity strategy, puts the other side: “This is not a bubble. It is a broad-based buildout with room for multiple winners. The AI opportunity is large, the fundamentals are strong, and the sector still has plenty of runway. The sector is being driven by real fundamentals, not hype. Demand for compute power is surging, and companies like Nvidia, AMD, Broadcom, and Marvell are leading the charge.”
He also argues that valuations across the sector are surprisingly reasonable. Most big tech names trade at 25-30x earnings, supported by 10-15% annual growth – well above broader market averages, though he admits some software names such as Palantir may be priced for perfection.
The only real solution for investors is to diversify. They need to find something that will defend a portfolio, should the AI trend start to wobble. That means being active rather than passive, incorporating unloved ‘value’ markets such as the UK, alongside other diversifying assets. The tussle over AI is likely to be a feature of markets for the foreseeable future.
