AI Bubble / Stocks too Expensive
Sonia K. from Kansas City, MO asks: Hi Mitch, the market just keeps going up, and I feel like I’m hearing about an “AI bubble” every week. I understand that market timing is a no-no, but should I (and other investors) be worried about how high everything is?
Mitch’s Response:
I think it’s very fair to feel a bit uneasy right now. Valuations in some of the market’s most concentrated areas are undeniably high, and investors seem to be assuming that artificial intelligence will unlock massive profits for years to come. This mix of strong performance, high expectations, and growing talk of bubbles creates an aura of high risk.
To answer your question straight away, I think it’s ok to feel some worry here, but I’d see it as a reason for heightened awareness, not necessarily alarm.1
Looking ahead to the final two months of the year, I would not be surprised by a sharp market correction. Remember, though, that corrections, when the market pulls back 10% or more in a short time, are a normal part of equity market investing and often a way for excess optimism to get released without doing lasting damage.
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Markets rarely move in straight lines, and short-term volatility often comes with the territory after periods of strong performance. Long-term trends still depend on earnings growth, profitability, and broader economic health, which I continue to see as constructive in the current environment. If corporate results continue to hold up, markets can eventually grow into their valuations.
Regarding the potential for an “AI bubble,” I again think it’s good for investors to keep this possibility on their radar. History reminds us that bubbes can build even when everyone’s talking about them, as we’re seeing today. The late-1990s dot-com boom was filled with warnings, but prices kept climbing as investors chased gains and fund managers felt pressure to stay invested. The same psychological forces are applying today, as few market participants want to sit out a rally and managers fear they have no choice but to invest, so as not to lag their benchmarks. This confluence of decision-making can stretch valuations well beyond what fundamentals justify.
At this moment, however, I see fundamental differences between 1999 and today. Many of the companies leading the AI charge are profitable, large, and well-established, not speculative startups with no revenue. Case-in-point: the ten largest U.S. companies by market capitalization (nearly all Tech companies) now operate with an average return on equity of 29% and net profit margins of 34%, a level never reached in the history of the S&P 500. These companies also tend to hold little debt and generate previously unfathomable levels of cash flow, which makes a collapse unlikely in the short-term.
Still, prices can overshoot even for solid businesses. When expectations get too far ahead of earnings, it doesn’t take much—a slower growth rate, a shift in interest rates, or just changing sentiment—for valuations to reset. That’s what we’re watching for now.
The key takeaway is that it’s fine to acknowledge the market feels stretched without rushing to extremes. Being a little cautious here makes sense, but trying to sidestep volatility entirely usually backfires.
Markets can look unnerving when prices run high and everyone’s talking about bubbles. But discipline, not prediction, has always been the stronger strategy.
Our latest guide, The Perils of Market Timing3, unpacks why even smart investors get caught chasing rallies or dodging pullbacks, and what history shows about staying the course when markets feel stretched. Inside, you’ll learn:
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Disclosure