Bubble trouble: This bull market has a very big question mark on it

It is conceivable that the massive spikes in their share prices represents the capitalisation of that potential, although you’d question, given how far and fast those prices have run this year, how much further they might have to go.

It’s also not clear whether it is momentum – retail investors, index funds and traders – driving the narrowly based bull market in those stocks, or a real conviction that they can turn the potential of AI into actual cash and earnings.

There are some threats that the big tech companies are facing, not the least of which is the increasingly aggressive regulation attracted by their dominant positions in online markets. Regulators around the world are also rushing to devise responses to the complex implications of adoption of AI technologies.

There’s also a more conventional challenge.

While the S&P500 might be up 15 per cent this year and 22 per cent over the past 12 months, it is still 7.5 per cent below its peak in late 2021 and the broader Russell 2000 is about 23 per cent off its 2021 highs.

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That’s largely attributable to the US Federal Reserve Board’s aggressive hiking of US interest rates over the past 15 months, which has seen the federal funds rate rising from near zero to above five per cent and raised the prospect of a US recession.

Whether the mega-techs can sustain their performance may hinge on what the Fed does next.

While the US central bank paused the cycle of 10 consecutive rate rises last week, members of the rate-setting Open Market Committee flagged the likelihood of two more rate rises this year. Markets are pricing in a probability that there will be only one before the cycle ends, with the next move beyond that the start of a decline in rates.

Technology companies are peculiarly sensitive to movements in interest rates because, as they are valued at high price earnings multiples, as rates rise the net present value of their future cash flows falls in an exaggerated fashion.

If the Fed follows through on its projection of two more 25 basis point increases in US rates they might be vulnerable, given that they already appear priced for perfection.

Despite the global slowdown in economic activity – spluttering and modest growth in China, Europe sliding into technical recession, the UK economy a mess and those of countries like Australia or Canada battling high rates of inflation, having only the narrowest pathways to avoid recession – the US economy has proven more resilient than expected and a soft landing or, at worst, a short and shallow recession (unless the Fed overplays its hand) is still possible, or at least conceivable.

The other macro influences that have helped the big tech companies are the absence of market volatility – the VIX, or “fear” index, has fallen from 26.5 per cent in mid-March to just over 14, well below its long-term average of about 21 – and a depreciation of the US dollar.

The dollar has fallen about 10 per cent against America’s major trading partners’ currencies since late September last year, boosting the competitiveness of US companies generally but the globally operating mega-techs in particular.

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That’s largely because there are other central banks, notably the European Central Bank, that have been more hawkish in recent months than the Fed and have further to go in their rate cycles than the Fed.

The skinniness of the base on which this bull market (the rise of more than 20 per cent from a low) has been built has created a gulf between the true believers in the transformative impacts of AI in the near term, those who think the excitement around AI is overhyped, and/or those who doubt the market’s ability to so clearly identify the long-term winners from transformative technologies.

While the base of the market’s resurgence has been broadening somewhat as this year has progressed, with the halo effect of the mega-techs helping the rest of the market, the resolution of that debate between the believers and the sceptics will have significant financial consequences for investors.

There’ll be big profits or losses for some and either losses avoided or very significant lost opportunities for others.

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