Wall Street analysts warn: The US stock market is forming a "double bubble," which could trigger a 30%-50% plunge if it bursts.

Wall Street analysts warn: The US stock market is forming a "double bubble," which could trigger a 30%-50% plunge if it bursts.

U.S. stocks have repeatedly hit new highs driven by the artificial intelligence boom, but Wall Street analysts are issuing rare warnings—the risks facing the current market go far beyond overvalued stock prices.

In their latest report, Panmure Liberum analysts Joachim Klement and Francisca Reis point out that the U.S. stock market is currently brewing both a "price bubble" and an "earnings bubble," with the two overlapping to form a "double bubble" structure.

Using the cyclically adjusted Shiller P/E ratio as a benchmark, and correcting corporate earnings to a long-term normal growth rate, the current valuation of the S&P 500 would reach 67.6 times, surpassing the peak of all historical asset bubbles in the U.S. BCA Research Chief Strategist Peter Berezin warns that once the bubble bursts, U.S. stocks could fall by 30% to 50%.

Even so, U.S. stocks have recently remained strong. As of the close this Monday, the S&P 500 is less than 1% from its all-time high, the Dow Jones Industrial Average broke through 53,000 points to set a new record, and the Nasdaq Composite Index rose more than 1%, with the semiconductor sector leading the gains again.

In the bullish camp, forward P/E (Forward P/E) is often cited as evidence that stock market valuations remain reasonable. According to Dow Jones market data, the S&P 500's forward P/E has fallen from 22.4 times a year ago to 20.51 times, even as the index has risen about 20% in that period. Behind this phenomenon lies the fact that Wall Street earnings growth expectations have exceeded the gains in stock prices themselves.

According to FactSet data, analysts currently expect S&P 500 constituents to see earnings growth exceeding 23% in the second quarter, marking the seventh consecutive quarter of double-digit earnings growth.

However, Klement and Reis note that this earnings growth rate significantly deviates from the long-term trend. The current earnings growth of S&P 500 per share is already 1.8 standard deviations above the long-term trend, reaching "abnormal" levels. They believe that if earnings growth is adjusted back to normal levels, the Shiller CAPE ratio would surge from around 41 times to 67.6 times, deviating from the long-term trend by 4.6 standard deviations, surpassing the peak of every historical asset bubble in the U.S.

Mega-cap Tech Companies Transforming, Pressure for Earnings Growth Normalization Emerging

Analysts identify the core risk of the current earnings bubble as concentrated in the "mega-scale cloud computing companies" represented by Microsoft, Alphabet, Amazon, Meta Platforms, and Oracle.

In his column in the UK Financial Times, Klement warns that "abnormal" profits cannot last forever. As these tech giants continue to invest heavily in AI data center construction, their business models are shifting from asset-light to asset-heavy, and this structural change will put pressure on earnings growth, gradually bringing it back to normal levels.

Klement also admits that such periods of high earnings growth often last longer than investors expect, and the current earnings surge could persist for several more years.

Historical Precedent: Low P/E Once Masked Earnings Bubble

BCA Research's Peter Berezin cites historical cases to further illustrate the dangers of earnings bubbles. He points out that before the outbreak of the global financial crisis in 2007–2008, banks and homebuilders also experienced irrational earnings booms, when low P/E ratios masked the unsustainability of profits.

"More generally, earnings bubbles are very common in industries characterized by boom-and-bust cycles, including natural resources, aviation, shipping, and the semiconductor sector which is particularly notable in the current environment," Berezin wrote in a report at the end of May. In his third-quarter outlook released last week, he further pointed out that Wall Street analysts have performed extremely poorly in identifying the peak of earnings bubbles, and once the bubble bursts, stocks could fall 30% to 50%.

Concerns about excessively optimistic earnings expectations are not isolated cases. Andy Costan, CEO of Damped Spring Advisors, said on the "Monetary Matters" program in May that the growth rate of the U.S. economy is insufficient to support the earnings levels preset by Wall Street analysts. Wall Street veteran Jim Paulsen also stated in a recent published article that he believes the current market's overly optimistic sentiment toward earnings has become a risk factor.

Meanwhile, U.S. stocks experienced turbulence in June, continuing into early July, with momentum trades centered on semiconductor stocks encountering resistance at times. However, the semiconductor sector regained momentum on Monday, lifting the Nasdaq Composite Index up by 1.1%, and market sentiment temporarily stabilized.

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