S&P 500, Nasdaq Hit All-Time Highs on AI Sector Surge

This week, the S&P 500 and Nasdaq Composite indices reached new all-time highs, driven largely by the robust performance of the artificial intelligence (AI) sector. While a potential cooling of the AI frenzy could put pressure on the indices, analysts suggest that this may not necessarily drag down the U.S. economy.

The current valuation of the U.S. stock market is indeed high, but price is not the sole indicator of whether an investment is worthwhile. Therefore, concerns about a repeat of the dot-com bubble are relatively subdued. Although the market is entering a traditionally unfavorable season, some investors may choose to take profits early. However, the AI-driven trading that has propelled large-cap tech stocks higher still has fundamental support.

One of the key drivers of this rally is the upward revision of earnings estimates for the "Magnificent Seven" tech giants and Broadcom. The average increase in earnings estimates for these companies for this year and next year is 3.3% and 2.6%, respectively. Microsoft, Apple, Alphabet, and Meta Platforms have seen their earnings estimates for 2025 rise above the overall S&P 500 level. By 2026, NVIDIA is expected to join this group.

Despite the fact that NVIDIA and Broadcom have not yet released their latest financial reports, the overall earnings season for the second quarter can be considered a success. The strong performance and upward revision of earnings estimates indicate that the earnings momentum of large-cap tech stocks remains robust, and it is expected to continue driving individual stocks and the broader market higher.

However, investors remain concerned about the proportion of AI in this rally. If not for the boost from generative AI, the S&P 500's year-to-date gain might have been only 3% to 4%, rather than the current 10%. The four companies—NVIDIA, Microsoft, Meta, and Broadcom—collectively account for 21% of the S&P 500's weight and have contributed an astonishing 60% of the 2025 gain.

Despite the concerns, the outlook for large-cap tech stocks remains positive. The four companies mentioned above have demonstrated that their current valuations have "no natural ceiling." While this may sound similar to the tech bubble of 1999, the current rally is backed by more solid earnings. However, there is a warning: if generative AI trading encounters setbacks, the S&P 500 could fall by at least 6%, or even more than 14%, especially if investor sentiment turns sharply negative.

This poses a risk for index investors, as these giants hold significant weight in the S&P 500. Historically, the bursting of the dot-com bubble coincided with a U.S. economic recession. However, the economic slowdown in the early 2000s was not solely caused by the tech stock collapse; the 9/11 terrorist attacks were also a significant factor.

It is noted that the current market is indeed susceptible to a waning of enthusiasm for AI-related tech stocks. Once investor optimism fades, the market will face headwinds. However, this does not necessarily mean an economic recession. Even in the face of potential policy uncertainties, including tariffs and criticism of the Federal Reserve by the White House, the U.S. economy may still maintain resilience or experience a scenario of mild stagflation, where economic growth slows significantly and inflation rises slightly. If AI performance falls short of expectations, the market may still decline in a macro-stable environment.