- Tuesday, November 12, 2024

Uncertainty about the election and recent stock market gains, which were heavily concentrated among Big Tech companies making unnervingly large bets on Artificial Intelligence, caused a great deal of stock market volatility in the last weeks of the campaign.

Steady your nerves. Stocks are reasonably priced and are a good place for ordinary folks’ long-term savings.

The S&P 500 price-earnings ratio is about 29. Over the last 25 years, it has averaged 26; at the last business cycle peak in February 2020, it was 27.

While that’s a bit frothy, American businesses are becoming decidedly more profitable.

Estimates for fourth quarter annual sales and profits growth are 4.8% and 12.7%, and for 2025, 5.7% and 15.1%.

If stock prices stalled, realizing those gains would pull the S&P P-E ratio below historical norms and make many companies’ shares inexpensive.

Goldman Sachs created a stir in October with forecasts based on Nobel Laureate Robert Shiller’s Cyclically Adjusted Price-Earnings ratio (CAPE) that the long-term outlook for stocks is poor. In particular, recent gains were too dependent on the lofty valuations of the Magnificent 7—Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia and Tesla.

CAPE is the ratio of average prices to the inflation-adjusted average earnings for the last 10 years. As of this writing, that figure was about 38, well above the 25-year average of 27.

Ten years is rather arbitrary and doesn’t correspond to the average length of business cycles—the most recent expansion lasted 146 months and was killed by the COVID shutdowns. Profits in the numerator for recent CAPE calculations are depressed by pandemic-period earnings.

The MAG7 accounts for one-third of the S&P500 and about half of this year’s gains in the index through the end of October.

The Goldman Sachs argument centers around the fact that it is difficult for large firms to sustain long-term outsized revenue and earnings growth. They expire the scope for gaining new customers once they dominate markets and then attract competitors and attention from antitrust regulators.

Nvidia graphics chips, which provide the foundation for its AI chips, are special-purpose semiconductors called graphic Processing Units (GPUs), as opposed to central processing units (CPUs), which are the brains of your personal computer.

AMD is launching its own GPUs to take on Nvidia.

Broadcom is the largest designer of application-specific processors and is teaming up with OpenAI to develop a specialized chip that performs inference functions—the running of AI agents trained for specific tasks.

None of those companies are among the MAG7. The salient point is that the technologies that power AI will create stronger growth and opportunities for others.

In the technology space, the companies to watch are those developing AI agents—specialized programs that can perform, for example, the functions of a travel agent or load and grid management for electric utilities.

Salesforce and Adobe are well familiar with such business applications. These are companies to watch, as are dozens of startups in the hands of entrepreneurs who have not yet hit our radar screens.

In all this, we should ask what the potential is for broader GDP growth and new profitable firms across the economy.

Since 2016, the U.S. economy has grown at 2.5% annually, well above the 1.8% long-term pace assumed by the Congressional Budget Office and Federal Reserve policymakers.

Spending on AI equipment and services is estimated to rise from $185 billion last year to about $900 billion in 2027 and increase labor productivity by perhaps one percentage point a year.

Many jobs will be created and destroyed, but the economy is poised for a growth trajectory closer to 3% than 2%, and it won’t just be companies we know.

Only 51 of the companies on the Fortune 500 list in 1955 remained on that list every year since—where were the MAG7 then?

Goldman Sachs analysis shows a higher expected return for 10-year Treasury securities than stocks.

In September 2021, CAPE computations were throwing off similarly bearish signals for stocks.

Since that time, the S&P500 has gained more than 25%.

Over the last 25 years, the average returns on the S&P500, 10-year Treasuries and real estate (single-family dwellings), have been 9.1%, 3.8% and 5.2%.

If you think you can pick the next Nvidia, have a look at it, but history teaches unicorns are tough to spot before their horn emerges.

My advice remains the same: Until you get close to retirement or need your capital for other purposes—like children’s tuition—it’s best not to overinvest in housing. Keep enough to tide you over emergencies in a money market and staggered maturity fixed income assets like Treasuries and CDs, and invest the rest in a diversified portfolio or index fund—especially IRAs and similar tax-sheltered accounts.

• Peter Morici is an economist and emeritus business professor at the University of Maryland, and a national columnist.

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