The S&P 500 is trading at valuations rarely seen in its history, raising fresh questions about how long the market’s powerful run can continue. One closely watched measure is now approaching levels last reached during the dot-com bubble, when enthusiasm around a new technology pushed stocks to extraordinary heights. Could artificial intelligence be creating a similar setup, or has today’s market earned its premium?
Valuations raise concern
Currently, the S&P 500’s cyclically adjusted price-to-earnings, or CAPE, ratio stands at 42.5. This measure compares share prices with inflation-adjusted earnings from the previous decade, helping smooth out shorter economic swings. Back in 1999, the ratio peaked at 44.2 as investors piled into internet-related companies. Generative AI is now driving another technology boom, although there is an important difference: many businesses benefiting from today’s rally are already highly profitable.
Nvidia, for example, reported $58.3 billion in first-quarter net income. Other infrastructure companies, including Micron Technology and Sandisk, have also seen sharp improvements as spending on AI hardware grows. Still, high valuations leave less room for disappointment. What happens if the expected profits from AI services fail to materialise? Demand for the chips, memory and data-centre equipment supporting them could weaken as companies reconsider spending.
What comes next
Another potential challenge is emerging from China, where companies are developing cheaper AI models while domestic hardware makers expand production. CXMT, for instance, plans to increase advanced-memory manufacturing for AI data centres, potentially adding more supply to a booming market.
Historically, expensive markets have sometimes been followed by painful declines, but a high CAPE ratio cannot predict exactly when one will arrive. Selling everything based on a warning signal therefore carries its own risk, particularly because interest-rate cuts or government stimulus can quickly change investor sentiment.
Long-term investors may instead prepare for greater volatility by keeping some cash or lower-risk assets available. Should stocks eventually tumble, lower prices could also create opportunities to buy strong companies at more attractive valuations.
