Get 40% Off
⚠ Earnings Alert! Which stocks are poised to surge?
See the stocks on our ProPicks radar. These strategies gained 19.7% year-to-date.
Unlock full list

Can AI Gains Compensate for a Low Expected Equity Risk Premium?

Published 02/23/2024, 08:06 AM
Updated 07/09/2023, 06:31 AM

The surge in demand for demand Nvidia's (NASDAQ:NVDA) computer chips for artificial intelligence (AI) applications inspires some observers to claim that a new era for the economy is dawning.

AI, runs the thinking among the most optimistic minds in this realm, will reorder and solve any number of issues on the macro front.

Inflation and growth are at the top of challenges that will potentially fade as an AI-driven world emerges, advises AI expert Patrick Fan, professor of business analytics at the University of Iowa’s Tippie College of Business.

“The notion of a virtuous cycle—wherein improvements in one domain precipitate enhancements across others—is particularly salient,” he says.

“In the AI-economic nexus, elevated growth could beget higher employment and income levels, spurring increased consumer spending and investment and fueling further economic expansion.

This cycle has the potential to underpin sustained economic growth and broad societal welfare.”

The stock market appears to be all-in on the idea. Powered by excitement over Nvidia’s blowout results and the implications for growth in an AI-driven economy, the S&P 500 Index rebounded to a fresh all-time high yesterday.

“A whole new industry is being formed, and that’s driving our growth,” says Jensen Huang, Nvidia’s chief executive officer and co-founder.

The question is whether the rise of AI — and the potential for related developments in the economy overall – renders traditional estimates of the equity risk premium meaningless.

The Capital Spectator doesn’t have an answer, but the question is top of mind as some conventional equity risk premium metrics continue to fade.

For example, a pair of workhorse models suggest that the market’s excess return over the “risk-free rate” has tumbled sharply in recent years (for details on these models, see this post).S&P 500-Equity Risk Premium Estimates

A few weeks ago Matt Smith, investment director at Ruffer, a London-based investment management services firm noted that:

“The market is fearless at this point” and that “From a risk-reward perspective, US equities in particular are pretty unattractive. They have a lot of momentum, but they are expensive.”

History suggests that “expensive” translates into relatively low or possibly negative expected returns.

The question before the house is whether history still applies in an AI-driven world. Mr. Market probably knows the answer, but as usual, he’s not talking, at least not in real-time.

Latest comments

If you cash out of Nvidia before the conference on March 18, you’re crazy. Fundamental still point to how inexpensive this company is. Earnings are astronomical and only going up for the next decade plus. Do not sell this company before it hits 1000.
Fearless = irrational exuberance + fomo.
Fearless =/= fomo.  "f" in "fomo" means "fear".
I see the problem with AI is that generally, it will solely benefit the bottom line. Considering that, it's also expected that AI will cost millions of jobs, leading to fewer consumers. All that leads to a 800 pound head on a 60-pound weak skrawny body (consumer). Wouldn't that would lead to total collapse?
That's Luddite talk.
Excellent article. Same thing was said in the past about wireless technology, the Internet, and IoT. Most investors don't truly know anything about Big Data or Machine Learning, let alone AI.
But market level is above levels from those things.
Nope
Risk Disclosure: Trading in financial instruments and/or cryptocurrencies involves high risks including the risk of losing some, or all, of your investment amount, and may not be suitable for all investors. Prices of cryptocurrencies are extremely volatile and may be affected by external factors such as financial, regulatory or political events. Trading on margin increases the financial risks.
Before deciding to trade in financial instrument or cryptocurrencies you should be fully informed of the risks and costs associated with trading the financial markets, carefully consider your investment objectives, level of experience, and risk appetite, and seek professional advice where needed.
Fusion Media would like to remind you that the data contained in this website is not necessarily real-time nor accurate. The data and prices on the website are not necessarily provided by any market or exchange, but may be provided by market makers, and so prices may not be accurate and may differ from the actual price at any given market, meaning prices are indicative and not appropriate for trading purposes. Fusion Media and any provider of the data contained in this website will not accept liability for any loss or damage as a result of your trading, or your reliance on the information contained within this website.
It is prohibited to use, store, reproduce, display, modify, transmit or distribute the data contained in this website without the explicit prior written permission of Fusion Media and/or the data provider. All intellectual property rights are reserved by the providers and/or the exchange providing the data contained in this website.
Fusion Media may be compensated by the advertisers that appear on the website, based on your interaction with the advertisements or advertisers.
© 2007-2024 - Fusion Media Limited. All Rights Reserved.