Vincent Nichols, BNP Paribas Asset Management in an interview to ET Now, explained that the current rally is not entirely unjustified. “Momentum has been driven by superior earnings growth, revenue expansion, and improving margins. These are fundamental drivers that continue to support the market,” he said.
However, Nichols cautioned that valuations in certain areas, particularly within large-cap tech, are beginning to stretch. “There’s a possibility that earnings may continue to justify these multiples, but there’s also a risk of a pause or slowdown, prompting investors to look at other parts of the market where fundamentals have been underappreciated,” he noted.
When asked about where an earnings pause might appear, Nichols emphasized that a slowdown might not necessarily come from earnings declines but rather from reduced momentum. “We could see a digestion period in capital expenditure and AI investments over the next few years. Even if growth pauses slightly, the amount being allocated is already substantial,” he explained.
The technology sector, which has been a major driver of growth, shows a mixed picture. “Tech valuations are generally higher than average, but margins and return on equity are much stronger than a decade ago. So, higher multiples may be justified as long as these fundamentals hold,” Nichols added.
Capital expenditure remains a key theme. Companies leading in investment are extremely profitable and primarily funding these initiatives through cash flow. Nichols stresses that much of this spending is driven by existential necessity rather than short-term ROI. “To stay competitive, firms must invest in AI and advanced computing. It’s a survival decision,” he said. On the global stage, US tech firms currently dominate in profitability, though China is rapidly advancing in technological development. “We haven’t yet seen comparable profitability from Chinese firms, but valuations there are attractive, leaving room for a potential catch-up,” Nichols observed. Interestingly, exposure to large-cap tech and AI is not a prerequisite for US market investors. Nichols highlights opportunities in small-cap equities, which have more exposure to cyclical industries like financials and industrials, and a healthcare segment distinct from large-cap counterparts. “Small-caps are trading near long-term averages and offer potential catalysts as earnings growth resumes,” he said, noting that small-caps may outperform large-caps over the long term.
As US markets continue to hit new highs, the debate between stretched valuations and solid fundamentals persists. Investors face a landscape where technology and AI dominate headlines, but small-caps and other sectors may quietly offer significant opportunities for long-term growth.
