Wall Street analysts warn: U.S. stocks are forming a "double bubble," which could trigger a 30%-50% crash once it bursts.

U.S. stocks are repeatedly making new highs amid the AI boom, but Wall Street analysts are issuing a rare warning— the risks facing the current market go far beyond just inflated stock prices.

In their latest report, Panmure Liberum analysts Joachim Klement and Francisca Reis noted that U.S. stocks are currently simultaneously building a "price bubble" and an "earnings bubble," and that the combination of the two forms a "double bubble" structure.

If the cyclically adjusted Shiller P/E ratio (Shiller CAPE) is used as the benchmark, and corporate earnings are adjusted to long-term normal growth rates, the current valuation of the S&P 500 would be as high as 67.6 times, exceeding the peak of every asset bubble in U.S. history. BCA Research chief strategist Peter Berezin warned that once the bubble bursts, U.S. stocks could fall by 30% to 50%.

Despite this, U.S. stocks have remained strong recently. As of Monday’s close, the S&P 500 was less than 1% away from its all-time high, the Dow Jones Industrial Average broke through 53,000 points to a record high, the Nasdaq Composite rose more than 1%, and the semiconductor sector again led the charge.

Forward P/E "distortion": Earnings growth expectations far exceed historical trends

In the bull camp, the forward P/E ratio is often cited as evidence that stock market valuations are still 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 so, the index has gained about 20% over the period. Behind this phenomenon is the fact that Wall Street earnings expectations have grown faster than the stock price gains themselves.

According to FactSet data, analysts currently expect second-quarter earnings growth for S&P 500 constituent companies to exceed 23%, which would be the seventh consecutive quarter of delivering double-digit earnings growth.

However, Klement and Reis pointed out that this earnings growth rate significantly diverges from the long-term trend. The current growth rate of earnings per share for the S&P 500 is 1.8 standard deviations above the long-term trend, which qualifies as a "non-normal" level. They believe that if earnings growth is adjusted back to a normal track, the Shiller CAPE ratio would jump from about 41 times currently to 67.6 times—deviating by 4.6 standard deviations from the long-term trend—and would surpass the peak of every asset bubble in U.S. history.

Mega-cap tech companies’ shift and the growing pressure to normalize earnings growth

Analysts identify the core risk of the current earnings bubble as the "hyperscale cloud companies" represented by Microsoft, Alphabet, Amazon, Meta Platforms, and Oracle.

In a column article in the Financial Times, Klement warned that ""supernormal" profits cannot last forever. As the aforementioned tech giants continue to make large-scale investments in AI data center construction, their business models are shifting from asset-light to asset-heavy, and this structural change will suppress earnings growth, gradually bringing it back to normal levels."

Klement also acknowledged that these high-earnings-growth cycles often last longer than investors expect, and the current earnings uptrend could still continue for several more years.

Historical precedent: Low P/E ratios once masked an earnings bubble

BCA Research’s Peter Berezin cited historical cases to further explain the dangers of an earnings bubble. He pointed out that before the 2007 to 2008 global financial crisis, banks and homebuilders also experienced an irrational earnings boom; at that time, relatively low P/E ratios masked the unsustainability of profits.

"More generally speaking, earnings bubbles are very common in industries with boom-bust cycle characteristics, including natural resources, airlines, shipping, and—especially worth watching in the current environment— the semiconductor industry," Berezin wrote in a report at the end of May. In his third-quarter outlook published last week, he further noted that Wall Street analysts have performed extremely poorly in judging the peak of earnings bubbles. And once the bubble bursts, the stock market could fall by 30% to 50%.

Concerns about overly optimistic earnings expectations are not unique. Andy Costan, CEO of Damped Spring Advisors, said on the May "Monetary Matters" program that the U.S. economy’s growth rate is not sufficient to support the earnings levels assumed by Wall Street analysts. Wall Street veteran Jim Paulsen also recently wrote publicly that he believes the current market’s excessive optimism about earnings has become a risk.

Meanwhile, U.S. stocks fluctuated in June and continued into early July. At one point, strong momentum trading centered on semiconductor stocks met resistance. However, the semiconductor sector regained upward momentum on Monday, driving the Nasdaq Composite up 1.1%, and temporarily stabilizing market sentiment.

Risk warning and disclaimer

        The market is risky; investment requires caution. This article does not constitute personal investment advice, nor does it take into account any particular users’ special investment objectives, financial situation, or needs. Users should consider whether any opinions, viewpoints, or conclusions in this article align with their specific circumstances. Investing based on this article is at your own risk.