In his latest memo named “On Bubble Watch,” Howard Marks, co-founder and co-chairman of Oaktree Capital, highlighted several warning signs in the stock market, including high valuations that may lead to poor long-term returns or short-term declines. While not calling it a bubble, he pointed to the S&P 500’s elevated price-to-earnings ratio, which historically correlates with lower returns. Marks also expressed concerns over AI investments’ excessive enthusiasm and overconfidence in the Magnificent Seven tech stocks, which have contributed significantly to the S&P 500’s recent gains. Marks also wrote:
“…..when stocks rise too fast – out of proportion to the growth in the underlying companies’ earnings – they’re unlikely to keep on appreciating. Michael Cembalest has another chart that makes this point. It shows that prior to two years ago, there were only four times in the history of the S&P 500 when it returned 20% or more for two years in a row. In three of those four instances (a small sample, mind you), the index declined in the subsequent two-year period. (The exception was 1995-98, when the powerful TMT bubble caused the decline to be delayed until 2000, but then the index lost almost 40% in three years.)
In the last two years, it’s happened for the fifth time. The S&P 500 was up 26% in 2023 and 25% in 2024, for the best two-year stretch since 1997-98. That brings us to 2025. What lies ahead?
The cautionary signs today include these:
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the optimism that has prevailed in the markets since late 2022,
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the above average valuation on the S&P 500, and the fact that its stocks in most industrial groups sell at higher multiples than stocks in those industries in the rest of the world,
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the enthusiasm that is being applied to the new thing of AI, and perhaps the extension of that positive psychology to other high-tech areas,
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the implicit presumption that the top seven companies will continue to be successful, and
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the possibility that some of the appreciation of the S&P has stemmed from automated buying of these stocks by index investors, without regard for their intrinsic value.”
READ ALSO: 15 AI Stocks That Skyrocketed in Q4 and 14 AI Stocks Making Waves on Wall Street.
Assessing the Future of AI Valuations
According to the JP Morgan report, AI investing: More broadening than bubble, the current valuation gap between the largest AI-linked companies (Mag Seven) and the rest of the S&P 500 is unlikely to last. These companies now represent a significant portion of the S&P 500’s market cap and have driven a substantial portion of its returns since 2023. While the AI industry is expected to fuel the next tech revolution, the important question for investors is whether market expectations are realistic.
Currently, companies involved in AI hardware and hyperscalers are dominating, but future growth could come from other sectors, such as AI developers and integrators. While many major tech firms have strong fundamentals, the high valuations may not be sustainable if the broader market does not fully adopt AI technologies. Investors should focus on opportunities across the entire AI value chain, especially where valuations are less stretched.
For this article, we selected AI stocks by reviewing news articles, stock analysis, and press releases. We listed the stocks in ascending order of their hedge fund sentiment taken from Insider Monkey’s database of 900 hedge funds.
Why are we interested in the stocks that hedge funds pile into? The reason is simple: our research has shown that we can outperform the market by imitating the top stock picks of the best hedge funds. Our quarterly newsletter’s strategy selects 14 small-cap and large-cap stocks every quarter and has returned 275% since May 2014, beating its benchmark by 150 percentage points (see more details here).
13. Kingsoft Cloud Holdings Limited (NASDAQ:KC)
Number of Hedge Fund Holders: 5
Kingsoft Cloud Holdings Limited (NASDAQ:KC) provides cloud services, including IaaS, PaaS, and SaaS, mainly in China. The company also offers R&D, digital solutions for enterprises, and public cloud services across sectors like video, e-commerce, AI, mobile internet, finance, public service, and healthcare.
UBS upgraded Kingsoft Cloud (NASDAQ:KC) to Buy from Neutral and raised the price target to $12.50 from $4.20. The firm highlighted strong Q3 performance, ongoing revenue and margin recovery driven by AI, and ecosystem support. UBS projects Xiaomi’s revenue contribution to Kingsoft Cloud will grow from 20% in 2024 to over 40% by 2027 and support 13% annual revenue growth. Despite a year-to-date price rally of over 100%, the firm believes the stock remains undervalued compared to other independent cloud providers in China.
12. Xometry, Inc. (NASDAQ:XMTR)
Number of Hedge Fund Holders: 7
Xometry, Inc. (NASDAQ:XMTR) operates an AI-powered marketplace that simplifies manufacturing by analyzing parts and offering real-time pricing and lead times. Its AI-driven Instant Quoting Engine connects buyers with global suppliers for efficient production.
RBC Capital increased its price target for Xometry (NASDAQ:XMTR) from $27 to $40, maintaining a Sector Perform rating. The firm noted that the software sector could have another strong year in 2025, driven by stabilized and, in some cases, improved spending trends, generative AI’s potential for innovation, and favorable year-over-year comparisons in the first half as companies focus on growth. The outlook forms part of RBC’s broader analysis of the software industry’s performance prospects.