S&P 500 stocks are a whopping 32% overvalued by a popular measure. And Vanguard says AI isn't going to be the savior many think.
Corporate earnings would need to soar 40% a year just for the S&P 50o to justify its current valuation, says a new report from Vanguard's Global Chief Economist Joe Davis. And a "meaningful risk of disappointment remains" for any investors thinking AI spending is going to fuel such growth, he says.
Profit growth in the S&P 500 hasn't gotten anywhere near that high — even following other breakthrough technological advancements. It only hit 21.5% following the dawn of electricity, 15% on computers and the Internet and 13.3% in the post Covid-19 economy.
"Investors looking to connect the dots between the current level of share prices, probable levels of economic activity, and the widespread enthusiasm for AI would be well-advised to temper any expectations that economic growth and corporate profits are set for near-term acceleration," Davis said.
A Trillion Dollars In AI Investment?
Much of the enthusiasm for AI S&P 500 stocks and Nvidia stem from the idea that $1 trillion in investment is coming soon. But Vanguard thinks that number, too, is a pipe dream.
Companies and governments spent just $67 billion on AI in 2023, says Vanguard. But even if that spending shot up at an aggressive rate, it would only hit $129 billion this year. Next year would be $248 billion. A more realistic growth rate points to AI investment reaching $81 billion in 2024 and $99 billion in 2025.
"But $1 trillion in AI investment by 2025 would require 286% growth," Davis said. "That's probably not going to happen, which means we're unlikely to experience an AI-driven economic boom in 2025."
Curb Your AI Enthusiasm
And while investors think AI will make the S&P 500 fairly valued, the numbers just don't pencil out. Investors are still paying too much for S&P 500 stocks. That's based on Vanguard's analysis of the cyclically adjusted price/earnings ratio.
Meanwhile, an aging population is further taxing government funds, putting more pressure on economic growth.
"At the same time, we see meaningful risk — a 30% to 40% chance — that AI produces more modest benefits that are insufficient to overcome ever-larger government deficits driven by age-related spending. In that case, long-term economic growth might reach only about 1% per year," Davis said.
Impossible Growth
How S&P 500 earnings grew following other innovations
| Period | Annualized EPS growth |
|---|---|
| All history (1871-2024) | 4.1% |
| Electricity | 21.5% |
| Computers and internet | 15.1% |
| Covid-19 rebound | 13.3% |
| Required from AI | 40% |
