AI Stock Market Fuel.
How much more can valuations rise?
As of late 2018 Apple became the first one trillion dollar company. Today, it is close to 5T. This sharp rise spreads across the board, especially for AI companies.
Despite how amazing AI is, there is a limit to how much can be invested in a single period, and it ultimately depends on how much money is available.
To get a notion of this limit, two shares are useful. First, the sum of all market capitalizations divided by M2. The second is the analogous for real estate valuations.
These shares are rather constant over time as money is invested when money is available. If they rise too much, it signals the investment rate as too fast.
Results
In the chart, it is intuitive to compare the 2008 values with current ones, but this misses one key aspect: money velocity.
Under given M2, if money circles around faster, capital is essentially more abundant and the shares with respect to M2 should rise. Comparison of the shares is most meaningful in periods where this velocity remains constant.
From 1997 to 2008 this was the case, as it oscillated only between 1.9 and 2.2. That explains the comparability of the dot-com and financial crisis peaks. Since 2008 the velocity trended lower and in 2019 reached 1.4. Therefore, a new peak is most probably going to take place below 2008 levels. Excluding the pandemic crash, velocity stayed constant since 2019, which enables a trustworthy comparison of the shares over M2.
Since the start of the equities rally until the 2001 peak, both shares combined rose 27.2%. In 2008, 30.5%, and for the period 2023 to 2026, that number is 24.8%.
Further, the upper chart allows to see what is driving those increases. In 2001 it was mainly equities, as the real estate share remained flat. In 2008, it was mixed but heavily weighted on real estate. Now stocks are solely responsible again.
Is there fuel for further valuation increases in equities?
With this data, it seems highly unlikely. Their share of M2 is mostly maxed out, so the main way to finance that has to be through rises in either M2 or money velocity.
As GDP is the product of these last two, the answer ultimately depends on GDP growth.
If it continues to rise in the future, equities can have some upside. If it doesn’t, there is almost nothing to gain, but a lot to lose. This is because M2 shares are mean-reverting.
See our GDP forecasts.