The U.S. stock market continues to hit new all-time highs, but the foundation of this rally is raising more and more questions. Consensus earnings forecasts for S&P 500 companies over the next 12 months have risen by 25% — the most aggressive expectations since the post-pandemic recovery. The pace of upward revisions over the past six months has been nearly 20%, a record high since 2021. However, in my opinion, such figures carry clear signs of overheating and the formation of a classic "earnings bubble."
Euphoria Amid AI: Foundation or Illusion?
The main drivers of this optimism have been shares of chipmakers and server manufacturers, which are at the epicenter of the artificial intelligence boom. Investors are pricing in the preservation of these companies' super-profits for years to come. However, as a number of leading Wall Street strategists note, such expectations are very rarely justified outside of phases of sharp post-crisis recovery. We are witnessing a situation where the market leaves almost no room for error: any slowdown in the growth rate of AI-related revenues could trigger a massive correction.
Risks of Overvaluation and Monetary Policy Tightening
Current multiples, while below the extreme levels of the dot-com bubble, still appear inflated. Stocks are trading at roughly 20 times expected earnings, leaving very little room for maneuver. The situation is exacerbated by changing expectations for the Fed's rate: traders are now pricing in at least one 0.25% hike by the end of the year, rather than a cut as previously assumed. This reversal creates additional pressure on already stretched valuations. Managers of the largest funds warn: the market has almost no "safety margin" ahead of the release of second-quarter earnings. If companies fail to consistently beat inflated forecasts, the consequences could be painful.
My assessment: The market has painted itself into a corner, extrapolating the current successes of the AI sector into an infinite future. Investors should prepare for volatility — the "earnings bubble" could burst at any moment, and then the correction will affect not only tech giants but the entire S&P 500 index.