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I’m looking to see if the stock market crashes between now and 31 October. Why? My fellow Motley Fool UK contributor Royston Wild is on holiday and he says share prices fall sharply when he’s away!
Now, that’s obviously not a serious reason to start thinking about selling shares. But it’s not actually that much worse than some of the reasons other people are citing right now…
Valuation
According to the latest hedge fund data from Bank of America, the thing most fund managers are looking at is valuations. Specifically, the multiples at which artificial intelligence (AI) stocks are trading.
Take Palantir (NASDAQ:PLTR) as an example. The company trades at a price-to-sales (P/S) multiple of 122 and that implies expectations of an awful lot of growth in a very short space of time.
I don’t even think Palantir is anything like the most outrageous example on the stock market right now. So I get it – valuations are high in some areas and these are a big part of the overall market.
Valuations alone, however, aren’t a good reason to expect the market to crash, and certainly not in the near future.
John Maynard Keynes
Superstar economist John Maynard Keynes was famous for saying the stock market can remain irrational for longer than you can remain solvent. He’s absolutely right and investors need to take note of this.
That saying frequently gets rolled out in the context of undervalued shares. The point is that the fact a stock is trading below its intrinsic value doesn’t mean it’s going up any time soon.
The same, though, is true the other way round. There’s no law of economics saying that when a company’s share price gets above its fundamentals it has to come down within a certain time.
What’s needed to cause a stock market crash is something to burst the bubble. And while there are a few candidates and anything could happen, I don’t see a reason to think this is imminent.
Growth
In the case of Palantir specifically, I think the main threat is clear. The company’s revenue growth has been huge, but if this slows, then that big valuation could be a problem.
What could cause it to slow? The most obvious thing, as far as I can tell, is a recession in the US. Outside of AI spending, GDP growth across the Atlantic has been weak and this is worth noting.
Another way of viewing the same data, though, is as a sign businesses are viewing AI spending as non-negotiable. And Palantir’s revenues from its US commercial division almost doubled in Q2.
The firm is free-cash-flow-positive and – unlike many other AI companies – this isn’t entirely offset by massive stock-based compensation costs. Despite the high price tag, I think it’s one to watch.
Final Foolish thought
By themselves, valuations don’t cause stock market crashes. So investors should be wary about seeing high multiples as a reason to sit on the sidelines and wait for prices to fall.
That’s not to say valuations don’t matter — they do over the long term. But if things go down sharply before the end of the month, I’m blaming Roy.
