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Investors waiting and watching to see if and when the “bubble” in artificial intelligence and Magnificent Seven stocks eventually pops would be wise to review some market history.
That’s according to a team of Bank of America strategists led by Michael Hartnett, who tallied similarities and differences between long-ago bubbles and what investors might be seeing currently. Spoiler: higher real interest rates are likely to be the eventual undoing of this group of stocks, they say.
After last year’s massive run up in the stock prices of seven Big Tech companies — Tesla Inc.
TSLA,
Microsoft Corp.
MSFT,
Apple Inc.
AAPL,
Amazon.com Inc.
AMZN,
Alphabet Inc.
GOOGL,
Nvidia Corp.
NVDA,
Meta Platforms Inc.
META,
— the gains are continuing for several of those names, alongside other technology companies.
Here’s Bank of America’s chart comparing South Sea and Mississippi bubbles of the 1700s, the roaring 20s for the Dow industrials and the dot.com bubble of the 1990s, among others, to the Magnificent 7 run thus far:
While “no two bubbles alike…similarities to gauge Magnificent 7 today are catalyst, price, valuation & ‘price of money’,” points out Hartnett and the team.
First the catalyst, where the strategists point out that past bubbles have been driven by “technological innovation, new geographical sources of growth and very crucially central bank easing,” a setup not dissimilar to today.
“The AI bubble was kick-started by the Fed response to SVB and ChatGPT…just as the Plaza Accord kick-started Japan, LTCM [Long-Term Capital Management], the internet, 9/11 and the housing bubble of 2000s,” said Hartnett and his team.
As for price — they refer to trough-to-peak asset gains — the 140% gain for the Magnificent Seven companies over the past 12 months is nearing the 180% rise for the Dow industrials
DJIA
seen in the 1920s and 150% for the Nifty 50, a group of blue-chip stocks that drove the early 1970s bull market. But the Magnificent Seven rise remains far off the 230% surge for the FAANG (Facebook parent Meta, Amazon, Apple, Netflix, Alphabet parent Google) stocks seen from the COVID-19 pandemic lows.
Read: The ‘Magnificent Seven’ is like the ‘Nifty 50’? If only they could be so lucky.
The Magnificent Seven’s group’s valuation, meanwhile, at 45 times earnings is still under most of the other bubble runs.
What counts it seems, for the eventual undoing of the Magnificent Seven run, is what they refer to as “price of money.” In 12 of 14 observed bubbles, bond yields were rising as those bubbles peaked or popped and financial conditions were tightening. For example, 4% real rates popped the internet bubble, 2% popped China’s stock bubble and 3% deflated the subprime bubble, to name a few.
So given “significantly higher” levels of global debt currently versus a versus history and 10-year real rates, at 2%, Hartnett and his colleagues say 2.5% – 3% rates will likely put an end to AI and Magnificent Seven glory.
For now, investors seem largely undeterred by any potential issues, with technology stocks — and corporate bonds — shaping up as the new “all-weather” asset classes for investors, said the strategists. On course for “blowout years,” tech sector funds have seen year-to-date annualized inflows of $85 billion this year, with $500 billion to investment grade bonds, they note.
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