- There's a "speculative orgy" in the stock market that's about to fall apart, one investing veteran warns.
- Overhyped AI stocks could soon deflate, with the most expensive name potentially crashing 70%.
The stock market is in the middle of the greatest "speculative orgy" seen in decades. That spells trouble for investors, who are being set up to fail by betting on the S&P 500 to continue its monster rally.
That's according to Bill Smead, a more than 40 year investing veteran and the chief investment officer of Smead Capital. Smead sees a major fallout coming for the stock market – not necessarily in the form of a stock market crash, but by the S&P 500 failing to generate any meaningful returns in the next 10 years, as overhyped artificial intelligence stocks see their valuations collapse and the rest of the market fails to pick up the slack.
That deflating process will stretch out over the next decade, Smead said, but investors could perceive the change as stark, given the extreme bullishness at the moment for the S&P 500's best-performing stocks.
"It's going to come like a thief in the night. All of a sudden, those things will go from the most popular thing since sliced bread to getting crushed," Smead told Business Insider. "Money will move from glam growth stocks to real asset companies."
Smead pointed to bubble-like characteristics forming in the S&P 500's most well-loved names. The Magnificent Seven — a group of mega-cap tech firms that have soared this year amid Wall Street's excitement for AI — have accounted for nearly all of the S&P 500's gains this year. The other 493 stocks, meanwhile, have stayed mostly flat.
In fact, tech stocks appear to be overvalued in general; the Nasdaq 100 is the most expensive its been compared to the Russell 2000 since the dot-com bubble. Meanwhile, tech stocks are at their most expensive compared to the S&P 500 in about 43 years, Smead wrote in a report this week.
That narrow breadth is a sign that the stocks that have gained the most this year are caught in a bubble and will be bound for a reversal in the coming years, Smead said. He describes that outcome as a "stock market failure." In that scenario, the most expensive stocks in the market could plunge as much as 70%, he predicted. Meanwhile, he said he'll be surprised if the S&P 500 makes investors any money at all over the next 10 years.
He couldn't predict when the turnaround would start to occur. The timing will hinge on market sentiment, he suggested.
"Manias die when they want to by running out of new maniacs," Smead said.
It doesn't mean that investors need to shy away from equities altogether. Investors are facing a good opportunity to buy "out of favor" stocks, Smead said, adding that his firm was bullish on oil, gas, bank, and homebuilder stocks.
His warnings run contrary to other strategists on Wall Street, who have making the case for another positive year for the stock market as the US looks poised to avoid a recession. The S&P 500 could end up rallying to a new all-time-high next year, Bank of America, Deutsche Bank, and Société Générale all recently predicted.