THElatest bulletin of the European Central Bank (ECB) has launched a clear warning on the possible risks of a correction in US stock markets. In particular, the analysis focuses on the valuations of the largest US technology companies, the so-called "magnificent seven": Alphabet (Google), Amazon, Apple, Meta, Microsoft, Nvidia and Tesla. These tech giants, which today represent approximately one-third of the capitalization of the S&P 500 index, have been to the center of an escalation of stock prices, which the ECB compares, in some respects, to the dot.com bubble of the 90s.
“Market concentration, high valuations and perhaps overly optimistic growth expectations” are the factors that today recall the experience of a technological boom similar to that of the past, as the ECB notes in its bulletin. The alarm, however, is not limited to the market value of these companies, but extends to growth expectations and equity risk premiums, which have supported stock prices, suggesting that a correction may be imminent.
The reasons behind the rise in stock prices
Since 2023, US stock prices have seen a significant increase, especially those of the "magnificent seven". Despite the tightening of monetary policies by the Federal Reserve and several geopolitical shocks, the Stock prices rose nearly 60% in 2023, with some titles having seen earnings above 75%. This phenomenon has led to the ratings of these companies a historically high levels, with the price-to-earnings (P/E) ratio reaching 30, well above the S&P 500 Index average of around 20, and well above the long-term median level of 17.
The ECB stresses that the strong increase in stocks was fuelled by a strong optimism about artificial intelligence (AI) and technological innovation. But while current returns are lower than at the peak of the dot.com bubble, the similarities with that period are undeniable. As happened in the 90s, enthusiasm for new technologies is fueling growth expectations that, if not verified, could lead to a market correction.
Analogies with the dot.com bubble
The recent boom in technology stocks is reminiscent, according to the ECB, in some ways, of the dot-com bubble. In the 90s, enthusiasm for the Internet had led to exorbitant valuations for many tech startups, many of which were in precarious financial condition, making extensive use of leverage.
Today, the “magnificent seven” are well-established companies, with a solid market presence and margins of significantly higher profits compared to the technology companies of the 90s. Furthermore, these companies own large liquidity reserves and access to low-cost financing, which allows them to invest in research and development, as well as acquire smaller competitors.
Market concentration and the role of large companies
A distinctive aspect of the current market, compared to the 90s, is the concentration of capitalization. The “magnificent seven” now represent about a third of the S&P 500 index’s capitalization, a share significantly higher than the 17% held by the major technology stocks during the dot.com bubble. This increase is partly due to their solid market position and high profit margins: about 20%, compared to the lowest profit margins (5-10%) of technology companies in the 90s.
Furthermore, these companies they are not dependent on leverage, like the tech startups of that period, but they enjoy large cash reserves. This allows them to continue to invest in research and development and make strategic acquisitions to maintain their dominance in the industry.
AI Optimism and the Role of Profits
The current stock market boom is supported by strong optimism about the potential of artificial intelligence. The expected profits for the “magnificent seven” continue to outpace other companies, fueled by confidence in emerging technologies. Artificial intelligence has become a recurring topic in corporate earnings reports, boosting investor optimism.
Analysts predict a double-digit earnings growth for the S&P 500 index in 2025 and 2026, well above the historical average. However, the ECB warns that the 18% annual earnings growth forecast for the coming years is relatively rare in the long run.
Historical experience suggests caution, since during the bubble dot.com growth expectations were never satisfied and, indeed, profits made decreased dramatically, leading to a correction in the markets.
Risk appetite and equity risk premiums
Finally, the ECB underlines the importance of investors' risk appetite in determining the trend of stock prices. In recent years, the equity risk premiums have fallen at record lows, fostering greater appetite for risk. This phenomenon has been particularly evident since 2022, when investors have reduced the premium required to invest in stocks, despite the tightening of monetary policies.
The ECB suggests that the low levels of equity risk premiums, combined with expectations of very high profits, were the main drivers of stock price growth, even in a context of global uncertainties and rising interest rates. The technology sector, in particular, has benefited from exceptionally low risk premiums, which, together with expected earnings, have supported the resilience of the stock market.
The ECB therefore warns that, despite the optimism, investors should carefully consider structural and historical factors which could lead to a market correction. Current valuations and high optimism about AI may not translate into sustainable long-term growth, and risk appetite may be set to normalize, which could impact stock prices.
