Is the AI/Nvidia bubble about to burst?

​​​Are AI stocks, and especially Nvidia, in a bubble?

​Recent discussions around Nvidia, Microsoft, and Apple focus on their ongoing battle for market cap supremacy but investors are increasingly aware that the concentration in these stocks is getting ever greater, leading some to cash in their profits and to invest their money in more defensive sectors such as utilities or real estate.

​This stock rotation has come at a cost to Nvidia’s share price which fell by around 16% over the past three trading days, shedding roughly $500 billion in market value since briefly becoming the world’s most valuable company last week. This decline has to be seen in context, though, since the AI chip maker’s share price is still up around 145% year-to-date.

​Nonetheless, with Nvidia’s gains alone making up roughly a third of the S&P 500’s year-to-date gains, concerns that a large enough sell-off in the chipmaker could trigger a market slump are becoming more widespread.

​Added to that the top 10 US stocks by market capitalization currently have higher valuations than during the 1990s dot-com bubble.

​Specifically, the forward price-to-earnings (P/E) ratio for these ten stocks is 27x earnings. That is the second highest valuation in at least 30 years, exceeded only briefly before the 2020 COVID market crash.

​During the 1990s dot-com bubble, the top ten stocks had a forward P/E of 24x before that bubble burst.

​Top ten US stocks, S&P 500 and S&P 500 excluding top ten forward P/E comparison chart

​Given these lofty valuations, some market watchers are concerned we could be in another stock market bubble, this time driven by the Artificial Intelligence (AI) craze.

​Importantly, the US top ten stocks account for almost 40% of the total market valuation of the S&P 500 index. So if these market leaders decline significantly, they could drag the overall index down with them.

​After 24 years without a major bubble bursting, there are reasonable questions around whether stocks are overvalued again and primed for a correction.

​US stock market concentration and annual returns during rising/falling concentration charts 1950-2023

​The above charts show that high and rising stock market concentration in itself is not necessarily negative for stock market performance. To the contrary, rising periods of concentration tend to coincide with increased positive annual returns.

​Nonetheless strategists and the financial media point out that Nvidia, in particular, has been flashing signs of being overbought, suggesting potential near-term pullbacks in its stock price, the beginning of which might already be underway. Sources like CNBC’s MarketWatch express concerns over the recent sharp rises in Nvidia’s stock, recommending close monitoring of key levels for these tech giants, especially given Nvidia's significant surges and it last week briefly overtaking Microsoft as the world’ largest stock by market cap.

​For some the situation encapsulates broader market concerns, highlighting that not just Nvidia or semiconductors, but the entire S&P 500 index shows signs of being overbought. Meanwhile, contrasting views from analysts propose that despite the overbought conditions and recent pullback, Nvidia could be just beginning its ascent, hinting at diverging opinions among market analysts on the future trajectory of these leading tech stocks.

​As of last week, the Nasdaq 100 is slipping from its record high, made marginally above the major psychological 20,000 mark, as Nvidia's sell-off continues, while the Dow Jones Industrials Average (Dow) is rising for a fourth consecutive day as investors rotate out of overbought tech stocks into old economy stocks. According to IG’s Chief Market Analyst Chris Beauchamp, “this kind of rotation is very healthy for a continuation of the rally into July,” as it leads to improved market breadth.

​Nvidia, Apple, Amazon, Microsoft and Tesla, one month share price comparison chart

​Speeches by Federal Reserve (Fed) officials potentially offering clues on near-term rate outlooks as well as the US Fed’s preferred personal consumption expenditures (PCE) inflation gauge, out on Friday, could move stocks further.

​Even if short-term several of the US’ mega cap stocks might work off their overbought conditions with their share prices giving back some of their strong year-to-date gains, the medium-to-long-term uptrends are likely to remain in play.

​After all, according to some analysts, over $6 trillion remains on the sidelines in high-yielding money markets, yet to perhaps be put to better use in the raging AI bull market.