What may have prompted many participants to jump into the AI stocks may have been the release of ChatGPT 3.0 in 2022, which opened the possibilities of generative AI. Chipmakers took a large part of this hype as AI requires powerful microchips. Nvidia’s stock
has surged more than 300% since its October lows as the firm holds around 95% of the market share of machine learning chips. Other chipmakers, like AMD
, also enjoyed massive gains, with the former surging by more than 100% since October and the latter around 50%.Nvidia
is trading around 45 times the estimated earnings for next year (just a few weeks ago the forward PE ratio was almost 60x). That’s still above around 19x forward PE ratio of the S&P 500. So, the AI market can be considered overvalued and new investors may avoid joining the action. Maybe that’s why there was a pullback in the stock market recently. One other risk to the AI euphoria is geopolitics. For the construction of their chips, most chipmakers are reliant on Taiwan company TSMC. Thus any tensions between China and Taiwan could affect the semiconductor market and AI market respectively.
Even if there is a further pullback in the stock market, it can be considered as a corrective phase rather than the beginning of a bear market. Most high-growth tech firms are valued by discounting expected cash flows for the quarters and years ahead. So, with Nvidia’s
and other chipmakers’ cash-flow-per-share expected to continue accelerating in the foreseeable future, and also bearing in mind market expectations of several rate cuts by the Fed next year, present values have the potential to continue rising.
Even if geopolitical tensions rise and leave their mark, a potential episode of market risk-aversion could prompt AI investors to increase their exposure to mega-cap, more established, tech stocks, like Alphabet
which are also expanding their business in the AI field. Along with Nvidia
, these giants are responsible for most of the gains in the S&P 500 since October.
For investors to start fleeing out of the stock market, not only does the Fed have to convince them that there are no rate cuts on the table for next year, but growth estimates for big tech firms in the upcoming earnings seasons may need to start disappointing. So, investors may see the current retreat, or any near-term extensions of it, as an opportunity to buy at more attractive levels.