Jason's World

An initial prediction of slowdown. Widespread fear of a market bubble. Dwindling predictions of rate cuts harming markets, then everything turning out to be far better than expected.

Sounds like last year, doesn’t it? True, but similar trends also seem to be playing out this year as stocks soar to their all-time highs and as of now, are remaining there. The artificial intelligence boom, led by Nvidia, has roared on, providing much-needed relief to markets as investors increasingly come to terms with a higher-for-longer interest rate environment that has seen interest rate predictions for the years ahead skyrocket-at around this point of the previous year, six rate cuts were priced in compared to one now, which until recently wasn’t even guaranteed.

The truly momentous surge of Nvidia, allowing it to meet the high expectations that investors set for it, propelled the stock market in the first half of the year. Since January of last year, the quarterly revenue of Nvidia more than quadrupled. Yet its EPS remains high, however investors see it lowering substantially as time passes, which gives it an estimated PE ratio of about 20 by the end of 2028, with a projected 2028 EPS of 6.45. This is much more in line with the PE ratios of most major tech companies, albeit it is on the lower end.

Such an EPS assumes that the price of Nvidia will remain flat all the way to 2028, which is a ridiculous assumption and if true bodes poorly for the stock. An alternative assumption would be that Nvidia’s earnings growth will be so high that the PE ratio figure will decline even as the stock rises rapidly. If we use Microsoft’s current PE of 39 for reference, this will suggest a projected stock price of 251.55 by the end of 2028. Not as impressive as the past year, but still an impressive haul-a near doubling of price in less than 5 years.

Meanwhile, economists have upped their estimates for the U.S. economy in 2024 even as their interest rate forecasts increased. The big picture painted is one of an economy that is heavily reliant on artificial intelligence as a driver. Yet information sector jobs remain below their 2022 peaks and continue to stagnate. The fastest-growing occupations are health care and social assistance-ambulatory care, hospitals, etc. Not to throw shade on those occupations, but they certainly throw cold water on the impression of an economy driven mainly by artificial intelligence.

This suggests that the impact of AI on the economy, at least for now, is not as direct. According to a report by Goldman Sachs, it will take some time to see material productivity gains from AI-their forecasts indicate that the impact of AI on productivity will be minimal if it exists at all until 2027, which means that the surprises in economic growth so far cannot be attributed directly to AI, the recent years have neither seen meaningful job growth in the tech sector nor broader productivity gains due to AI.

Another hypothesis, one that I have suggested in the past, would be the continued presence of excess pandemic savings. Even though previous analyses have found that Americans have saved more than expected, as of March those savings have been fully spent, and yet consumption has not abated, with consumers beginning to tap into their normal savings, pushing excess savings into negative territory.

So what explains all these surprises in economic growth? Here I will offer a hypothesis that is present in prior research but rarely mentioned on most financial news outlets. American stock ownership is famously common compared to other major economies-in Europe, only 13% own mutual funds, and only 11% own stocks. In Japan, only 15% of household assets are held in stocks, compared to 51% in the United States. In China, 220 million Chinese own stocks, about 20% of the adult population. Compare that to the 61% of Americans who hold stock. In America, investing is not just a rich man’s game, which results in the stock market having a much more significant impact on America’s economy than the economies of other countries. 

The boom of the stock market in 2023 and 2024, in the absence of any material gain directly brought by AI in terms of job growth or productivity, reflects a self-fulfilling prophecy. The hype around AI pushes up stock prices, broadly  increasing the asset prices of American consumers, leaving them with more latitude to make purchases beyond their typical means. This fuels the largest sector of the American economy, consumer spending, which makes up two-thirds of the economy-$18 trillion. The increase in spending boosts public perceptions of the economy and further raises the stock market, and so on and so forth.

The unique correlation between the economy and stock market in America grants it a unique strength. During the COVID-19 pandemic, the United States had the least worst economic downturn among the G7 nations, likely cushioned by the rapid recovery in the stock market following the immediate start of the pandemic. This stock-fueled American economy, despite criticism of its alleged overvaluation, creates gains that are both strong and widely shared, as opposed to countries like China. Even though its growth still outpaces that of the United States, there is a general feeling of malaise in China, with young people laying flat and businessmen and elite fleeing the country for Australia, Singapore and the United States. Furthermore, a recent economic report has flopped, showing China’s economy growing at a pace much worse than predicted.

What will this all mean for the economy going forward? Former President Trump, a famous advocate for lower interest rates, is likely to win the presidency. He has advocated for further corporate tax cuts to as low as 15%, in addition. However, the extent to which he will be able to carry out his tariff proposals will be a wildcard-the stock market has prospered under his first despite many of his trade wars, but his proposal of a 10% baseline tariff and a 60% tariff on Chinese products could make things more complicated if he manages to push them through.

There is a reason why American politicians pay attention to the stock market to a degree unlike politicians in other democratic countries-the people have a real stake in the stock market unlike any other major country on Earth. In my opinion, it was a core reason as to why a recession was averted in 2023, and it will be a core reason as to why investors’ expectations for 2024 have risen.