"Are the future growth benefits of AI compelling enough to buy stocks today that are trading on very high multiples? The S&P 500 Information Technology index is currently trading with a price-to-earnings ratio of 28 times – more than 5 per cent lower in terms of earnings yield compared to the current yield on high-yield bonds.
"However, valuation has rarely stopped them. These are companies with strong balance sheets, little debt, a lot of cash, and producing goods and services that enterprises and consumers want.”
He says this has helped broad equity market performance in recent weeks, but is sceptical that earnings growth expectations currently baked into valuations will be achieved.
Iggo says: “The bottom-up consensus for the MSCI All Country World equity universe is for 10 per cent growth over the next year. That is more than achieved in 2023 (so far) with a much higher pace of nominal growth. If those growth estimates are to be met, it puts even greater pressure on AI-related technology stocks to deliver.”
Erin Browne, portfolio manager for asset allocation at Pimco, says that US equities are generally trading at valuations above their long-term average, but says if one excludes the seven largest stocks, then the valuations are at around long-term average levels.
Her view is that with earnings expectations so high, the prudent thing may be to focus on companies already demonstrating they can achieve profits, rather than those which have valuations based on future expectations.
David Thorpe is investment editor at FT Adviser
