Special Edition: Can AI boost S&P 500 all the way to 15,000 points?

Special Edition: Can AI boost S&P 500 all the way to 15,000 points?

In this What’s Up with Stonks Special, let’s mull over whether it’s possible for the S&P 500 index to reach 15,000 points in the next 7 to 10 years.

Investors and the media love radical market views. Although it’s usually the bearish doomsday soothsayers who make the headlines, this time the dramatic changes are being prophesied at the other extreme. I came across a small American investment manager's view that the SP500 index could rise to 15,000 points in the next 7–10 years. That would be an increase of about 210% from the current level – and that’s not counting the dividends.

Sometimes (not always!) there are valid arguments behind wild ideas. The investment manager argues that the use of AI will cause a productivity leap that pushes the stock exchanges to triple from their current levels. Unlike the dot-com bubble, where the hype was mainly about internet stocks, AI affects and benefits each and every sector. Therefore, shares such as NVIDIA that are at the heart of the AI revolution would not be the only winners; in other sectors, the use of AI will lead to increased productivity and widening profits. AI can do jobs that would otherwise need hired workers which would increase costs. For example, industry and health care are in the early stages of utilizing artificial intelligence.

According to the investment manager, even though the most popular so-called Magnificent Seven stocks are expensive, the rest of the US stocks are quite cheap.

The idea of the S&P 500 at 15,000 points is not as absurd as it may sound at first. If the index were to climb there in 10 years, it would mean an annual return of 12%. In practice, that’s the same it has returned with dividends over the last 10 years. On average, the index has returned 10% with dividends in nominal terms over the last 60 years, so an annual return of 12% before dividends would be a stretch compared to history, but not an outlandish one. In the 1990s, for example, the S&P 500 index quadrupled, returning 15% a year, but the rally ended in a historically large bubble.

Perhaps the bigger problem is the valuation of shares. In the short term, the stock markets may deviate from their fundamentals, i.e. current values that are based on cash flows, but a sharp rise in stocks over a 10-year horizon will require genuinely strong profit growth. The S&P 500 index currently trades at almost 20x its forecast earnings. It would be somewhat erroneous to assume that the valuation multiple could be stretched significantly further.



That is unless the growth rate and the profitability of the companies in terms of return on capital improve even further structurally. Profitability has so far been fairly stable with return on capital hovering at an average of 14% over the past 30 years, so this would require a historical upward shift.

 

In absolute terms, the S&P 500 companies make an estimated profit of a couple of trillion dollars. If the valuation multiples do not change much, the results should reach over $6 trillion in ten years. And if the results move roughly with the economy, the size of the economy should triple in ten years. The nominal GDP of the United States has tripled in nominal terms over the last 24 years. This means that a significant acceleration in economic growth in the United States and in other parts of the world would be required. Tripling the S&P 500 would also hoist the absolute value of the index to $120 trillion, almost 20% above the size of the current global economy.

Therefore, I think that the prophesy of 15,000 points in 10 years relies largely on the potential of AI to improve productivity and consequently economic growth, as well as on companies’ ability to cash in on said economic growth. As I pointed out in the Christmas Special, previous historical upheavals such as steam power, railways, robots, or the internet did boost the economy, but more in a calm evolutionarily way than in a revolutionary leap. The predicted impact of artificial intelligence on the economy would be something we have never experienced in technology before.

So, looking back on history, I would be cautious about the potential of AI. Experts have a tendency to underestimate the complexity of automating other people's jobs. Technological leaps also tend to create new challenges. For example, in principle, a smartphone can combine the work of a computer, phone and camera and multiply efficiency. In practice, people may use the phone mainly to browse cat videos on TikTok – an activity that has a more limited impact on productivity growth. Another example is Facebook that is basically a platform that runs automatically on content generated by free users and driven by its own algorithms. But in practice, the company has had to hire 15,000 moderators to control the content. New inventions can lead to unforeseen problems.

So, it’s difficult to say what the ultimate impact of AI on the productivity of companies will be. Perhaps it‘s even likely that the S&P 500 will reach 15,000 points with general economic growth at some point in the next few decades. However, for my taste, the 10-year forecast is still unnecessarily optimistic unless the stock markets go into a yet another bubble.

Comfortingly enough, the wealth management company estimates that the winners are evenly distributed across different sectors. Right now, investors’ attention is largely focused on obvious winners such as Microsoft (which just became the most valuable company in the world) and NVIDIA. But the beginning of revolution rarely foretells the final winners: After all, the first leaders of the French Revolution ended up in the guillotine. Terry Smith, head of Fundsmith, wittily pointed out in his annual newsletter  a while ago how, the first pioneering companies were rarely the ultimate winners of the game in the dot-com hype. All Finns know the rise and fall of Nokia, the dominating titan of the early days of mobile phones that ended up as a snack for Apple. Even the AI boom can devour its children.

Such predictions also have an ominous echo reminiscent of the over-enthusiasm of the 90s. In 1999 was published the epically titled book Dow 36,000: The New Strategy for Profiting from the Coming Rise in the Stock Market. The book argues that the old dusty investment rules no longer apply; stocks are cheap and ready to quadruple in an instant. Let it be noted that Dow Jones peaked at 11,000 at the time but dropped below 8,000 when the bubble melted. The 36,000-point threshold was actually reached only last year, more than 20 years later.

It also takes a while to recover from bubbles. The Japanese stock market index has been in the headlines many times lately, as it has gone higher than in decades. Still, the general index is staying slightly below the levels of the superbubble that occurred over 30 years ago. It would take something very odd to prevent new all-time peaks in the stock market sometime in the future. The wait has been a long one, though.

In the end, I would advise to tread lightly with this prediction, although in the long run you should be optimistic about equities.

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