The artificial-intelligence craze and a "loosey goosey" Federal Reserve monetary policy have helped to spawn another bubble in U.S. stocks, according to a strategist who anticipated the dot-com crash of 2000.
According to Albert Edwards, a global strategist at Société Générale known for his bearish takes on markets and the economy, the stock-market rally over the last five months has all the hallmarks of a bubble, including tacit help from the Fed and a convenient narrative: that the "artificial intelligence revolution" will drive a boom in corporate earnings.
But the reality is that AI has yet to deliver stronger earnings growth outside of a handful of companies, like Nvidia Corp $(NVDA)$. As a result, analysts' earnings revisions have failed to keep up as the S&P 500 index rallied nearly 30% in five months, according to FactSet data, driving valuations to levels that are expensive relative to recent history.
The S&P 500 recently traded at more than 20 times forward earnings, which is above its five- and 10-year averages and the highest level since January 2022, according to FactSet.
So far, AI hype isn't feeding through to expectations for stronger earnings in the immediate future. Over the past six months, the share of analysts' earnings revisions that are upgrades has trended lower for both the S&P 1500 Composite XX:SP1500 and the Nasdaq-100 NDX.
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In the past, the S&P 500 has closely tracked analysts' optimism, Edwards said but more recently, the relationship appears to be heading in the wrong direction.
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As stock-market bulls wait around for AI to drive earnings into the stratosphere, "those of us who lived through the late 1990s TMT bubble have heard it all before and roll our eyes skyward," Edwards said.
Instead of being driven by stronger profits, the true source of the market's strength appears to be abundant Fed-induced liquidity. Edwards is hardly alone in pointing this out.
The notion that the Fed's quantitative tightening has led to tighter monetary policy is "a joke," Edwards said. While the Fed shrinks its bondholdings via quantitative tightening, the central bank's money-market operations are more than offsetting the liquidity drain by pumping more money into the financial system via the consistent drain in the Fed's reverse-repo facility.
This has caused the monetary base in the U.S. to expand over the past year, which isn't exactly consistent with the Fed's claims to be draining liquidity from the financial system, Edwards said.
Meanwhile, the U.S. economy has received plenty of help from the federal government in the form of huge fiscal stimulus, which has helped it avoid a recession despite the Fed's interest-rate hikes, Edwards said. Consumers tapping into their excess pandemic-era savings and signs that large companies are increasingly benefiting from higher interest rates and "greedflation" have also helped support economic growth, he said.
Edwards is extremely familiar with the conditions that led to the dot-com bubble. After all, he was one of a handful of people on Wall Street to anticipate the crash that began in March 2000, when the S&P 500 and Nasdaq hit their bubble-era peak, kicking off a bear market that would last for nearly three years.
After seeing their strongest start to a year since 2019, U.S. stocks have gotten off to a rough start in the second quarter. The S&P 500 SPX was down 59 points, or 1.1%, in recent trade on Tuesday at 5,204, on track to fall for a second-straight day. The Dow Jones Industrial Average DJIA shed 449 points, or 1.1%, to 39,116. Meanwhile, the Nasdaq Composite COMP was off by 254 points, or 1.6%, at 16,140.