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As S&P 500 hovers around all time highs, it’s hard not to wonder whether we are inside an inflating bubble. This week I’ll share some talking points that cover both sides of the debate.


The bubble case centers on higher than normal valuations, market concentration and speculation driven by AI. Compared to historical averages, the S&P 500’s PE ratio is elevated based on expected future earnings. If you smooth out earnings and adjust for inflation over the last 10 years, PE is close to where it was during the 1929 crash and dot-com bust in 2000.


Additionally, most of the S&P 500’s gains are concentrated in the Magnificent 7 AI stocks with extremely high performance expectations, suggesting that the rest of the market isn’t necessarily propelling the market forward. If these market-driving stocks fall short of expectations, the S&P 500 could start deflating.


Overall, there’s a lot of speculative enthusiasm surrounding AI and its benefits, which is reminiscent of the 90s internet bubble. Though businesses are actually seeing financial benefits from AI, the real question is whether increased efficiencies and productivity will result in meeting the very lofty future earnings expectations that investors are pricing into the market. And despite these frothy indicators—and the fact that other indicators such as employment, consumer purchasing power and corporate earnings are facing pressure—the market soldiers on. This could be perceived as bubble behavior.


Now for some signs that suggest that we’re not inside an inflating bubble and that perhaps it’s different this time. If the Fed continues to cut interest rates, it will only help bolster growth and earnings with lower borrowing costs, catalyzing expansion across industries, especially among small businesses. And unlike the dot-com bubble, the AI technology underlying Mag 7 growth is undeniably transformative. It can be argued that the earnings growth potential from AI and adjacent infrastructure spending will easily catch up to nosebleed valuations.


Finally, consumer spending remains stable, despite head winds, which is critical to  sustaining corporate revenues and broadening economic growth. This could continue to fuel the market rally on the basis of fundamentals rather than froth.


Whether we’re in an inflating bubble or just a higher-altitude market, be sure to stay disciplined, stay data-anchored and stay the course. So keep an eye on this week’s reports where fundamentals still outweigh frenzy and keep an ear out for the sound of hissing air.



“October. This is one of the peculiarly dangerous months to speculate in stocks. The others are July, January, September, April, November, May, March, June, December, August and February.”— Mark Twain


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P.S. I'm sharing some investment information, but it's important to remember that what I'm providing is for informational purposes only and should not be construed as financial advice.


Happy Investing,

John


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