The stock market has been on a remarkable trajectory over the past several years. The S&P 500 index has surged about 57% in just the past two years and has more than doubled in the past five. This dramatic rise has significantly impacted net worths, pushing some people past their retirement goals.
But is this growth sustainable, or is it indicative of a financial bubble? To understand this, we need to revisit the basics of what investing in stocks entails. A stock represents ownership in a company, akin to owning a rental property where you collect rent.
Similarly, stocks allow you to earn a share of a company’s profits. The price someone is willing to pay for a stock typically reflects the expected future earnings of the company. As a comparison: if you managed to buy stocks worth $100,000 in 2019 and reinvested the dividends, today your investment could be worth approximately $256,960, which is a 157% gain.
However, the earnings from that $100,000 investment have only increased from about $5,290 per year to $7,540, a mere 42% gain. This disparity implies a rising Price-to-Earnings (P/E) ratio, signaling that stocks are more expensive relative to their earnings than they were five years ago.
Rising stocks and AI-driven growth
The current market growth has been heavily driven by just seven companies: Apple, Nvidia, Microsoft, Amazon, Google, Facebook, and Tesla—collectively known as the “Magnificent Seven.” These high-performing tech giants make up over 25% of the market and have much higher P/E ratios than the rest of the market. This concentrated growth has been fueled by enormous advances in Artificial Intelligence. Six out of these seven companies are heavily investing in AI infrastructure, hoping to drive future profits.
For example, Nvidia’s revenue has surged as it supplies supercomputers for AI development. There is optimism that AI could lead to significant advancements, from novel-writing and contract analysis to medical diagnoses and autonomous driving. Yet, these developments come with uncertainties, including potential cost overruns, competition, or even societal impacts like unemployment if AI automates many jobs.
The reality is that nobody can predict the future with certainty. Historical patterns show that US economic growth has averaged about 3% per year after inflation over several decades, despite drastic changes. While artificial intelligence may enhance productivity and propel growth, there are unanswered questions about its broader economic and social ramifications.
Investors today are banking on extraordinary future growth from these tech giants, but whether these expectations will materialize remains to be seen. As with any investment, a diversified approach and caution are advisable, especially in times of rapid technological change and high market valuations.
Photo by; Jason Briscoe on Unsplash
