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AI carries ongoing stock market rally, renewing bubble concerns

Investor enthusiasm for artificial intelligence has carried the broader stock market throughout the first half of 2024 as companies closely tied to the technology recorded outsize gains.

The S&P 500, which settled at new all-time highs 31 times throughout the first half, ended June up nearly 14.5% from the end of 2023. AI stocks fared far better, with the S&P Kensho Artificial Intelligence Enablers & Adopters Index jumping nearly 27.5% through the first half. The index tracks the stock performance of companies developing AI or companies expected to benefit from AI technology adoption.

This rapid rise has renewed concerns over just how far the rally can run and whether a new bubble has formed.

"The AI rally is absolutely not sustainable, but it's only the early innings of the story," said Paul Schatz, president of Heritage Capital. "AI is the best story out there and an easy narrative to spin and sell."

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Outsize gains

NVIDIA Corp. is arguably driving this AI rally. Stocks in the semiconductor company, one of the most prominent names associated with AI, gained nearly 150% through the first half and saw its market cap climb to $3.32 trillion on June 18 from $1.22 trillion at the end of 2023, when it was briefly the largest stock on the S&P 500.

The largest stocks on S&P Kensho's AI index all significantly outgained the S&P 500 in the first half, including Broadcom Inc., which climbed nearly 44%, and Meta Platforms Inc., which increased about 42.5%.

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"Shorter-term, [AI companies] are delivering earnings and free cash flow against a slowing U.S. economy. Longer-term, the promise of productivity improvements will help offset aging demographics," said Joe Kalish, chief global macro strategist at Ned Davis Research.

In addition, the communication services and IT sectors rallied 26.1% and 27.8%, respectively, through the first half, far outpacing any other industry. About 74% of the AI index is made up of stocks from those two sectors.

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"The AI rally is coming mostly on the back of earnings growth," said Sonu Varghese, global macro strategist with Carson Group. "It's likely sustainable as long as these firms continue to make capex investments in AI."

Broadening out

The outsized increases in AI stocks could be partly due to the uncertainty surrounding the economy and monetary policy. With the Federal Reserve holding borrowing rates relatively high, investors may be crowding into the largest AI stocks seeing the biggest gains. As the Fed moves to cut rates, potentially this September, the rally in the stock market could broaden out, said Michael Arone, chief investment strategist for the US SPDR business at State Street Global Advisors.

"The economy has cooled but not entered recession, the labor market is still strong, inflation is falling, the consumer is in good shape and businesses, both their earnings are growing and their margins are fat," Arone said. "This is a good environment."