How long will the good times for stock investors last?

Published on: 17 April 2024

For stock markets it seems the only way has been up in recent months. We asked Olivier van Hirtum, APG's Head of Developed Market Equities Fundamental, if he's worried this is a bubble, how he prepares for a possible market correction, and what early warning signs he looks out for. "We hear fantastic stories about AI, but more than ever we need to see the numbers that back them up."

In summary

• Despite challenging circumstances, corporate performance remains strong and stock valuations are mostly still rational and fundamentally sound.

• The hype around AI resembles what happened in the dotcom boom, and a bubble might be forming in the AI segment of the market.

• Profitable business models based on AI technology may take longer to develop than many investors expect, which may lead to corrections in the short to medium term.

To start with the million-dollar question: are we witnessing a stock market bubble that can burst any day?

"That's more of a multibillion-dollar question I would say, and one that I can't answer with a simple yes or no. Some context is needed to analyze what's going on. First, geopolitical circumstances these days create quite a lot of uncertainty. We have a full-scale war on European soil for the first time in decades, relations between the US and China are strained, tensions in the Middle East are rising. From a macroeconomic view, things aren't all rosy either. In the last year we've had to deal with inflation levels we haven't seen in decades. As a result, interest rates have risen from the extreme lows of recent years, to a more normalized level. We're still dealing with the aftermath of the covid pandemic and the supply chain disruptions it caused, and China is no longer the growth engine for the world economy it used be. Another factor I think is relevant but is often overlooked is the demographic trend in many developed countries: population aging and a shrinking labor force are working against economic growth."


So far you've only mentioned factors that are difficult to square with the market’s record highs.

"That's right, but what stands out against this backdrop of uncertainty is that companies and corporate profits are generally still healthy. They don't seem to have suffered too much for example from rising interest rates. In China and also in Europe economic growth is disappointing, but companies, with a few exceptions of course, haven't run into serious difficulties. And in the US, still the world's most important economy, the fear of a recession that gripped investors last year has completely disappeared, which has given stock markets a real boost. So yes, current price-earnings ratios are high, but not extremely high from a historical perspective and not at levels that makes me start to worry. What further sustains current stock valuations is the confidence among investors that should things take a dramatic turn for the worse, central banks and governments will intervene. It's been a while since anyone used the term quantitative easing, but the fact that in the past monetary authorities have been willing to deploy such instruments when necessary, is still in the back of investors' minds. So in my opinion, despite all the political and economic uncertainty we face, stock valuations are still rational and fundamentally sound, for the most part."


Does that “for the most part” mean you have identified certain exceptions?

"We think that in the AI segment there could be a bubble forming. There, valuations and stock prices, in particular those of the so-called Magnificent Seven, have increased tremendously. We believe that the hype has run ahead of reality now and that using the technology to develop profitable applications will take longer than current valuations suggest. We've seen this before with the internet and mobile phones: one can quickly see the potential benefits, but these have taken many years to materialize. In the meantime investors are bound to be disappointed and that may lead to corrections. We have positioned ourselves for the possibility that this will happen to some stocks that have benefitted from the AI hype. Of course we do recognize the tremendous potential of AI in the longer term, but I guess we are a bit more cautious as to when this will materialize."

It's better to invest in the companies that provide the shovels and pick axes than to dig for gold yourself

Many companies that collapsed in the internet bubble could only offer projections of future growth while they burnt lots of cash. Today's tech companies are some of the biggest and most profitable on the planet and they won't suddenly collapse. How does that factor in your analogy?

"The flip side of that argument is that these companies are mature and already so big that their prospects for spectacular further growth are intrinsically limited. But you wouldn't know that from the fantastic stories they tell about the potential AI holds for them. If you replace ‘AI’ with ‘the internet’, these stories very much resemble what we heard in the dotcom bubble at the end of the nineties. But we've reached the point where we, more than ever, we need to see the numbers that back such stories up. An example here is a payments provider that recently announced it was replacing large numbers of its customer service staff with AI bots, which would lead to large efficiency and quality improvements. But when you dig a little deeper, you soon find there is less to these claims than first meets the eye. That has strengthened our view that caution is in order."


How have you positioned yourself specifically to reflect this caution?

"By taking the lesson from the Gold Rush to heart that says that it's better to invest in the companies that provide the shovels and pick axes than to dig for gold yourself. So we distinguish between the companies that sell the chips used in AI and the machines to make them, and the companies that use AI. Specifically this means that we prefer to be overweight in companies like Nvidia and ASML, and underweight in for example Apple and Microsoft. We believe that the valuations of these latter companies have been inflated with expectations which they'll not be able to realize, at least not in the short term."


Nvidia shares exploded after they announced their latest quarterly earnings, lifting many other stocks in their wake. Doesn't that suggest that expectations for Nvidia are over inflated as well?

"First, we're very positive about Nvidia and their products, management, market position and so on. That said, at the moment they do have an outsize influence on market sentiment. As a stock investor with over 25 years of experience, it does make me quite nervous when criteria for market success become defined so narrowly. The pressure on the stock is very high, and investors are beginning to count on Nvidia far exceeding their expectations. Just meeting them is no longer sufficient, that's how market psychology works. But at some point that's simply no longer possible. Market sentiment often turns out to be very fragile in such circumstances, and then investors overreact and stock prices could take a nosedive."


Earlier you touched on a number of developments - structurally higher interest rates, demographics, deglobalization - that create headwinds for corporate profitability. Wouldn't you say that at some point these factors will negatively impact the current stock market boom?

"I agree, but that's just not what we're seeing in the markets yet. Neither do I see a single development or event, other than an escalation between Russia and NATO, that could trigger a market collapse. There's no housing market bubble like before 2008, banks are solid, consumers and companies are not over-leveraged, so I don't see things turning around quickly. Of course these are rather dangerous statements, so they come with no guarantees. But these are the sort of questions we ask ourselves every day, and so far we haven't found anything that would make us change our view completely. Personally I keep a close eye on the value of the bitcoin. Not because I find it interesting in itself, but because I think it's a good indicator of market sentiment. It tells you something about the extent to which investors are willing to ignore negative news and remain euphoric about the future. Given that the bitcoin has almost doubled in value since the beginning of 2024, that doesn't point to a bubble that's about to burst either."