Lori Calvasina, Head of US Equity Strategy at RBC Capital Markets, has expressed growing concerns about the potential for an AI-driven bubble in the US stock market. This comes after previously refuting such claims, arguing that the current fundamentals of the economy are more robust than those present during the TIMT bubble of the early 2000s. However, a particular chart comparing the weights of the top 10 stocks in the S&P 500 to their share of total earnings has triggered concern.
According to RBC's data, the weights of the S&P 500's top 10 stocks have reached all-time highs, surpassing 44%. This is the highest level since at least 1990. However, the share of these companies' earnings in the total earnings of the index's companies has not fully followed the same trajectory, suggesting a potential disconnect between valuations and actual financial performance.
Calvasina noted in her report, "While we generally disagree with the view that the stock market is in an AI bubble, we do think this risk has increased." The term TIMT refers to the Technology, Internet, Media, and Telecommunications bubble that peaked in the early 2000s.
AI stocks significantly dominate the top 10 companies in the S&P 500. These include NVIDIA (NVDA), Meta Platforms (META), Broadcom (AVGO), Microsoft (MSFT), Amazon (AMZN), Alphabet (GOOGL) (which RBC counts as two stocks due to its dual-class ownership structure), and Tesla (TSLA). The only company in this group that is not directly and significantly related to the AI theme is Berkshire Hathaway.
It is worth noting that this is not an entirely new phenomenon. Calvasina mentioned that the overall growth in the weights of the largest companies in the S&P 500 has been faster than their share of earnings since at least 2021. This is largely attributed to investors' willingness to pay a premium for stronger long-term earnings growth expectations, especially after ChatGPT ignited the AI investment craze in late 2022.
However, the expansion of this gap has accelerated in the past few months. As of the latest available data at the end of October, the S&P 500's top 10 companies accounted for 34.3% of the total net earnings of all the index's companies. This widens the gap between these companies' weights and their share of earnings to 9.9 percentage points. This is not far from the 10.3 percentage point gap seen in March 2000.
As many of the AI giants, or so-called "hyperscalers," have reported their earnings in the past few weeks, concerns about an AI bubble have resurfaced. Although warnings about high valuations were already issued by Wall Street in the first half of 2023 when this trend first began to emerge.
Meta's stock plummeted last week, eroding over $200 billion from its market capitalization. Two Wall Street analysts downgraded the stock after criticizing the company's more aggressive AI-related spending plans. The stock fell again on Monday, further reducing its year-to-date gains to approximately 8.9%.
Gains in other large AI-related stocks, particularly Amazon, helped offset some of the losses, and US stocks ended last week higher for the third consecutive week.
One portfolio manager noted that Monday's agreement between Amazon and OpenAI to provide the private AI company with cloud computing capabilities helped the stock market continue its rally at the start of November trading.
US stocks were mixed on Monday, with the S&P 500 and Nasdaq Composite closing higher. Meanwhile, the Dow Jones Industrial Average and the small-cap Russell 2000 index closed slightly lower.
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