AI hype pushes US equity market back to dangerous equity valuation
The rally in US technology stocks this year, and in particular AI-related stocks, due to the market pricing in Fed rate cuts as the Fed will be forced to respond to lower economic growth, has pushed US equity market valuations to the highest level since July 2022. As we wrote in yesterday’s equity note, the global semiconductor industry has reached the highest equity valuations since early 2010 as growth expectations for semiconductors due to trends such as AI, electric vehicles and data center have fever levels. It almost feels like an echo from past bubbles.
Our combined equity valuation index on US equities reached 0.82 standard deviations above the historical average since 1992 up from 0.21 in September 2022. In other words, the US equity market never repriced below its long-term average underscoring the strong sentiment in US equities. If we look at what the current equity valuation means for future returns, based on past patterns, then we can see that the expected 10-year annualised real rate return is between -3% to +3% suggesting significant downside risks relative to the long-term average of +5% real rate return. Lofty equity valuations often goes hand in hand with overextended equity valuations in growth pockets of the market leading to subsequent outperformance of value stocks, which AQR co-founder Cliff Asness also recently predicted at the Morningstar Investment Conference.