US stocks are overvalued due to unrealistic expectations of AI-powered economic growth, Vanguard says

• Investors are overly optimistic about AI’s short-term prospects, Vanguard said.

• Companies will need to grow profits by 40% a year over the next three years to match valuations, the firm said.

• “That’s double the annualized rate of the 1920s, when electricity lit up the nation,” Vanguard writes.

With tech companies still pushing the limits artificial intelligence, the market’s enthusiasm for it seems endless.

But this enthusiasm expects too much from technology in too short a time, Avant-garde written on Thursday.

Wall Street is full of optimistic predictions about the effects of artificial intelligence on the economy and corporate profits. Most of them are linked to a revolution in the world of work in the United States and a boom in productivity.

That optimism has helped fuel strong stock market gains, with the benchmark S&P 500 index up 18% year-to-date through Thursday.

But Joe Davis, Vanguard’s global chief economist, believes expectations are too high and says stocks are overvalued even if the AI ​​boom plays out as expected.

He estimates that U.S. corporate profits would need to grow 40% annually over the next three years to justify the current level of stocks. To put that in perspective, the S&P 500’s one-year earnings growth rate through the second quarter of 2024 was 10.9%, according to FactSet Data.

“I am optimistic about the long-term potential of artificial intelligence to dramatically increase worker productivity and economic growth,” wrote Joe Davis, global chief economist. “But I am pessimistic about AI’s ability to justify high stock market valuations or save us from a period of economic weakness this year or next.”

He continued: “That’s double the annualized rate of the 1920s, when electricity lit up the nation – not to mention economic output and corporate income statements.”

Such a historic surge in corporate performance seems even less likely if the economy slows next year. Vanguard expects GDP to grow by just 1% to 1.5% in 2025.

It’s not that the investment firm has no faith in AI’s potential: its research suggests there’s a 45% to 55% chance that AI will trigger an explosion in labor productivity. Between 2028 and 2040, that could lead to an annualized growth rate of 3.1% in the U.S. in real terms.

But investors need to abandon any idea that this will happen immediately, Davis said. While companies have has poured billions into advancing Given their position in the industry, some market participants are wrong to believe that investment in AI will reach $1 trillion in the near term:

“A $1 trillion investment in AI by 2025 would require 286% growth. That’s probably not going to happen, which means we’re probably not going to see an AI-powered economic boom in 2025,” he said.

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Some on Wall Street are much more pessimistic. BlackRock has said there is a high probability that massive investments in AI will trigger higher inflation before production can boom, which could erode corporate profit growth.

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