Have artificial intelligence (AI) stocks entered “bubble” territory?

A strong rally in share prices globally has led to increasing talk of a stock market “bubble” in recent months. Shackleton Chief Investment Officer, Charlie Lloyd and Senior Portfolio Manager, Wayne Nutland share their thoughts on valuations, and revisit the important topic of diversification, before explaining the rationale behind the current composition of the portfolios they manage, the Esprit strategies, including the VT Esprit funds.

 

Technology companies have once again captured the imagination of investors, owing to big share price moves and the potential for significant productivity improvements from the increasingly widespread deployment of artificial intelligence (AI), which in turn requires both more complex computational resource and power.

Recent months have seen a number of investment deals from the technology giants, including both listed companies like NVIDIA and private businesses such as OpenAI. These developments have led to concerns that the huge increases in capital expenditure or “capex” (traditionally meaning investment by businesses into their core infrastructure, such as buildings and equipment) being witnessed may not translate into an economic return. This, in turn, has revived memories of the “vendor financing” which characterised the late 1990s TMT bubble, where equipment and software producers provided credit to their customers to purchase their products. Clearly, AI offers big opportunities, but also potentially big financial risks – not to mention the potential effects, whether positive or negative, for societies more broadly.

Judging whether or not the current levels of capex will lead to an economic return, over what time period, and for which companies, essentially requires a crystal ball. For now, we will leave this issue to one side, and instead focus on the areas which we can assess, namely equity market exposures, and valuations.

Critically, we think it is important to distinguish between the large, highly profitable US technology stocks, and smaller, less profitable, more speculative areas of the market which have exhibited greater signs of investor exuberance of late. Funds like the ARK Innovation ETF and funds linked to quantum computing and nuclear technology have seen returns of 50-90% over the last six months. This article focuses on the large US technology stocks where we have meaningful exposures within the portfolios we manage on behalf of Shackleton clients.

Performance: separating the reality and the hype

Given the “noise” of the news headlines, it may come as a surprise to some readers to learn that, so far in 2025, the FTSE 100 index of leading London Stock Exchange-listed companies has delivered a similar return to the US stock market, as represented by the S&P 500 index, and the so-called US “Magnificent 7” stocks (Alphabet, Amazon, Apple, Tesla, Meta Platforms, Microsoft, and NVIDIA). Furthermore, as sterling has strengthened compared to the US dollar, when all three are expressed in sterling terms, the FTSE 100 has actually delivered a stronger return so far this year.

Valuations – are they really that stretched?

Whilst valuations for the US “Magnificent 7” are certainly higher than for UK equities in aggregate, and for US equities more broadly, it is important to note that Magnificent 7 stock valuations have not in fact expanded significantly over the course of this year; indeed, at the time of writing, valuations (as expressed for example by the most commonly used stock valuation measure, the price/earnings ratio) are similar to the level seen at the start of 2025, and lower than the valuations seen during the post-Covid period.

The main driver behind the strong share price performance of these companies over recent years has essentially been profit growth. Since these companies have delivered consistently strong and expanding profitability, their valuations have remained broadly steady, with their valuations (as measured, for example, by their price/earnings ratios) declining from the levels of the post-Covid period, strong share price performance notwithstanding.

Magnificent characteristics

In the context of talk about stock market “bubbles,” we believe it’s important to bear in mind that the large US technology companies not only continue to demonstrate strong profit growth, but also that they enjoy high profit margins, and strong balance sheets. Whilst AI is very important to their future growth potential, in most cases, they have strong businesses aside from AI, having dominated areas like cloud computing and software. Considering the strengths of these companies, it would be surprising, in the current environment, if their shares didn’t trade on elevated valuations relative to many other companies.

So what?

This is not to say that valuations for US companies and the Magnificent 7, in particular, are not elevated, perhaps even “frothy,” but rather that financial market bubbles are usually characterised by significant increases in both share prices and valuations. However, this hasn’t been the case when considering 2025 so far, or when taking a longer-term view of valuations. To provide some context, it is worth pointing out that the Nasdaq Composite index (which includes a very significant weighting in technology stocks) returned approximately 100% during the calendar year 1999, with over 50% being generated in the fourth quarter of that year alone.

Turning back to valuations, whilst the current US Magnificent 7 stocks trade on a “forward price/earnings ratio” of around 30 times (as a reminder, this means the current share price, expressed as a multiple of the company or index’s expected annualised earnings per share – so in this case, the total combined market value of all of the companies in the Nasdaq Composite is roughly 30 times the total annual combined earnings of all of the companies in the index), during the late 1990s bubble, the Nasdaq Composite traded on a trailing (meaning retrospective, rather than forward-looking) price/earnings multiple of over 80 times.

Decline or crash?

After any period of strong share price returns, leaving shares trading on relatively elevated valuations, as the Magnificent 7 stocks are currently, a share price decline is always possible. There are a number of possible reasons for this, including for example investors’ desire to “take profits” after a prolonged period of rising share prices. Indeed, we did see a decline in share prices earlier this year, when the Magnificent 7 stocks fell some 25%, measured in US dollar terms (and nearly 30% when measured in sterling). Such corrections are painful, and could easily happen again, but we think that the magnitude of declines seen in the early 2000s (when the Nasdaq Composite fell some 80%) are unlikely, without a massive change in the fundamental outlook for the economy and markets.

AI exposure in the VT Esprit strategies

In addition to exposure to large US technology stocks through holdings in US equity funds, we have owned the Landseer Global Artificial Intelligence fund (formerly Sanlam) since 2018. Since launch, the fund has outperformed the overall global equity market by over 150%, with 2020 a standout year for the strategy. Recognising that valuations in some areas of the market are extended, including a large cohort of currently unprofitable companies, we have dialled back the holding size across the Esprit funds on several occasions in 2024 and 2025.

Unlike most peers, the fund invests in companies that have materially adopted AI to gain a competitive advantage, not just companies operating in the technology sector. This demonstrates the managers’ conviction that we are still in the early stages of a multi-year transformation that will continue to drive AI adoption deeper into the global economy. This provides AI-related equity exposure beyond the US mega-cap names, with one third of the fund invested outside of North America, thereby contributing to the VT Esprit funds’ diversification – an important and fundamental principle of prudent investment.

Overall conclusion

Whilst the recent performance of some areas of the markets undoubtedly reflects exuberant investor behaviour, we don’t think the large US technology stocks exhibit bubble-like characteristics, although their valuations are elevated and continued future profit delivery is likely to be key to sustaining share prices.

Given the relatively high valuations of the large US technology stocks and the fact that they represent such a large part of global equity markets, diversification is important, both by asset class (in a manner consistent with client risk profiles) and within asset classes. Turning back to the decline in the Magnificent 7 stocks earlier in the year, over the same period, portfolios in the Esprit range fell between 6% and 15%, highlighting the importance of risk profiling and diversification. Given the qualities of the US Magnificent 7, we believe they deserve to continue to have material positions in our portfolios. The overriding message, however, is that diversification is critical, and in our view, exposures to other equity regions and factors offer potentially higher future returns and, importantly, differentiated return profiles. This is precisely what we will continue to focus on delivering for our clients.

Top 10 equity exposures in the Esprit range

Top 10 equity exposures for global and US equity tracker funds

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Important information:

This document is issued by Shackleton, which is a trading style of Shackleton Advisers Limited. Shackleton makes no warranties or representations regarding the accuracy or completeness of the information contained herein. We have prepared the following document based on our view of the current market. Nothing in this document shall be deemed to constitute financial or investment advice in any way. We recommend you speak to your adviser before making any decisions. This document shall not constitute an invitation or inducement to any person to engage in investment activity. Past performance is not a guide to future returns and the value of capital invested and any income generated from may fluctuate.

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