Finance

Optimism about the potential of AI to drive future profits has powered the tech-heavy Nasdaq Composite to gains of more than 31% year to date.
Nvidia stock closed Thursday’s trade up 190% so far this year, while Facebook parent Meta Platforms has gained more than 154% and Tesla 99%.
In a recent research note, Morningstar drew parallels between the concentration of huge valuations and the dotcom bubble of 1999, though Coop said the differentiating feature of the current rally is that the companies at its center are “established giants with major competitive advantages.”

An AI (Artificial Intelligence) sign is seen at the World Artificial Intelligence Conference (WAIC) in Shanghai, China July 6, 2023. 
Aly Song | Reuters

Market participants are “overconfident” about their ability to predict the long-term effects of artificial intelligence, according to Mike Coop, chief investment officer at Morningstar Investment Management.
Despite a pullback so far this month, optimism about the potential of AI to drive future profits has powered the tech-heavy Nasdaq composite to add more than 31% year-to-date, while the S&P 500 is up by more than 16%.

Some analysts have suggested that a bubble effect may be forming, given the concentration of market gains in a small number of big tech shares. Nvidia stock closed Thursday’s trade up 190% so far this year, while Facebook parent Meta Platforms has risen more than 154% and Tesla 99%.
“If you look back at what’s happened over the last year, you can see how we’ve got to that stage. We had the release of ChatGPT in November, we’ve had announcements about heavy investment in AI from the companies, we’ve had Nvidia with a knockout result in May,” Coop told CNBC’s “Squawk Box Europe” on Friday.
“And we’ve had a dawning awareness of how things have sped up in terms of generative AI. That has captured the imagination of the public and we’ve seen this incredible surge.”

In a recent research note, Morningstar drew parallels between the concentration of huge valuations and the dotcom bubble of 1999, though Coop said the differentiating feature of the current rally is that the companies at its center are “established giants with major competitive advantages.”
“All of our company research suggests that the companies that have done well this year have a form of a moat, and are profitable and have sustainable competitive advantages, compared with what was happening in 1999 where you had lots of speculative companies, so there is some degree of firmer foundations,” Coop said.

“Having said that, the prices have run so hard that it looks to us that really people are overconfident about their ability to forecast how AI will impact things.”
Drawing parallels to major technological upheavals that have re-aligned civilization — such as electricity, steam and internal combustion engines, computing and the internet — Coop argued that the long-run effects are not predictable.
“They can take time and the winners can emerge from things that don’t exist. Google is a good example of that. So we think people have got carried away with that, and what it has meant is that the market in the U.S. is very clustered around a similar theme,” he said.
“Be mindful of what you can really predict when you’re paying a very high price, and you’re factoring in a best case scenario for a stock, and be cognizant of the fact that as the pace of technological change accelerates, that also means that you should be less confident about predicting the future and betting heavily on it and paying a very high price for things.”
In what he dubbed a “dangerous point for investors,” Coop stressed the importance of diversifying portfolios and remaining “valuation aware.”
He advised investors to look at stocks that are able to insulate portfolios against recession risks and are “pricing in a bad case scenario” to the point of offering good value, along with bonds, which are considerably more attractive than they were 18 months ago.
“Be cognizant of just how high a price is being paid for the promise of what AI may or may not deliver for individual companies,” Coop concluded.
Correction: This story was updated to reflect the year-to-date change of the Nasdaq Composite stood at 31% at the time of writing. More

A Six Flags Great Adventure “Clean Team” crew member disinfects the Wonder Woman: Lasso of Truth ride every 30 minutes.
Kenneth Kiesnoski/CNBC

Check out the companies making headlines in premarket trading.
UBS — Stock in the Swiss bank ticked up 4.6% before the opening bell following news that UBS ended a $10 billion loss protection agreement and a public liquidity backstop with Credit Suisse. UBS also confirmed that Credit Suisse fully repaid a 50 billion Swiss franc emergency liquidity loan to the Swiss National Bank.

Six Flags — The amusement park stock slipped 2.5% after missing on second-quarter estimates. The company reported adjusted earnings of 25 cents per share on $444 million in revenue, while analysts polled by Refinitiv forecast 78 cents and $459 million.
Maxeon Solar Technologies – The clean energy stock tumbled 26% in premarket trading after Maxeon said demand was weakening. Second quarter revenue of $348.4 million missed a guidance range that started at $360 million. Maxeon said it expected revenue to total between $280 million and $320 million in the third quarter. High interest rates was one reason Maxeon cited for the demand issues.
Savers Value Village — The thrift store retailer climbed nearly 6% on the heels of an earnings beat. The company notched adjusted earnings per share of 22 cents on $379 million in revenue, while FactSet had forecast 17 cents and $375 million.
Flower Foods — The baked goods company added 2.4% after beating on the top and bottom line in the second quarter. Flower Foods earned an adjusted 33 cents per share on $1.23 billion in revenue, while Refinitiv put the consensus at 28 cents and $1.2 billion.
Archer Aviation — Shares soared nearly 23% after Archer settled a lawsuit with Boeing over an autonomous flying dispute. Archer also recently completed a $215 million equity investment round, including contributions from United Airlines and Cathie Wood’s Ark Investment Management.

IonQ — The computing hardware firm added 8.2% after posting a wider-than-expected quarterly loss and a revenue miss. IonQ did, however, raise its booking guidance to a range of $49 million to $56 million.
— CNBC’s Jesse Pound contributed reporting More

Huawei on Friday reported 2.2% year-on-year growth in its consumer business revenue for the first half of the year.
That was slower than the company’s overall revenue increase of 3.1% to 310.9 billion yuan during that time.
The modest growth comes alongside China’s slower-than-expected economic rebound this year, and U.S. sanctions on the company that began in 2019.

Huawei’s production campus is pictured here on April 25, 2019, in Dongguan, near Shenzhen, China.
Kevin Frayer | Getty Images News | Getty Images

BEIJING — Chinese tech giant Huawei on Friday reported 2.2% year-on-year growth in its consumer business revenue for the first half of the year.
The modest growth comes alongside China’s slower-than-expected economic rebound this year, and U.S. sanctions on the company that began in 2019. Those business restrictions have since weighed on results.

At 103.5 billion yuan ($14.27 billion) in first six months of 2023, Huawei’s consumer revenue was less than half what the segment had generated during the same period in 2019 and 2020.
The 2.2% pace of growth was also slower than the company’s overall revenue increase of 3.1% to 310.9 billion yuan in the first half of the year.
Huawei’s ICT infrastructure business, which includes carrier and enterprise services revenue, contributed the most to overall revenue with 167.2 billion yuan for the first half of the year.

Cloud services brought in revenue of 24.1 billion yuan, while intelligent automotive solutions — whose products include tech for new energy vehicles — saw revenue of 1 billion yuan in the first six months of 2023.
Huawei has its own electric car brand, Aito, which claims to have produced 100,000 vehicles in 15 months through a partnership. Those sales are generally counted as part of the consumer business.

The consumer segment is the only unit with year-on-year comparable figures since Huawei didn’t start reporting revenue breakdown by cloud and other industries until late last year.
Huawei reported a significant increase in its net profit margin of 15% in the first half of the year, up from 5% in the year-ago period. The company attributed the improvement to better management systems and gains from the sale of certain businesses, which it did not specify.
The company also pressed ahead in its efforts to monetize artificial intelligence by launching in July an AI model for improving safety and efficiency in mining operations.
Second-quarter overall revenue grew by 4.8% year-on-year to 178.8 billion yuan — the fastest pace since only the fourth quarter of 2022, according to CNBC calculations.

Looking for smartphone growth

Overall revenue growth in the first half of 2023 comes off a low base. Huawei previously said its revenue barely grew in 2022 after reporting in 2021 its first annual revenue decline on record.
In 2019, the U.S. under President Donald Trump put Huawei on a blacklist that restricts the ability of American companies to sell to the Chinese telecommunications giant. That includes licensed access to the latest versions of Google’s Android operating system.
Huawei has instead released its own system, called Harmony OS. Earlier this month, the company announced the latest version of that operating system — and claims it was downloaded over one million times in three days.
This year, Huawei expects the launch of its flagship consumer products to return to a “normal” schedule, amid a slump in the smartphone market. The company did not share the extent to which there had been delays. In 2019, CNBC reported Huawei pushed back the release of a foldable phone.

Read more about China from CNBC Pro

In March, Huawei released its P60 smartphone, Mate X3 foldable and Watch Ultimate wearable, whose sales contributed to first-half growth in consumer business revenue, the company said.
“The industry and global markets will remain rife with uncertainty for the rest of 2023,” a Huawei spokesperson said in a statement.
“Nevertheless, we are continuously building out our mechanisms for global business continuity management and our agile operations management system,” the spokesperson said.
“We are confident that we can meet our annual business targets and continue creating value for customers and society at large.”
— CNBC’s Arjun Kharpal contributed to this report. More

UBS on Friday said that it has ended a 9 billion Swiss franc ($10.27 billion) loss protection agreement and a 100 billion Swiss franc publicly liquidity backstop that were put in place by the Swiss government when it took over rival Credit Suisse in March.
Credit Suisse also fully repaid the emergency liquidity assistance loan of 50 billion Swiss francs to the Swiss National Bank in March, as Credit Suisse teetered after a collapse in shareholder and investor confidence, UBS confirmed.
“These measures, which were created under emergency law to preserve financial stability, will thus cease to exist, and the Confederation and taxpayers will no longer bear any risks arising from these guarantees,” the Swiss government said in a statement Friday.

The logos of Swiss banks Credit Suisse and UBS on March 16, 2023 in Zurich, Switzerland.
Arnd Wiegmann | Getty Images News | Getty Images

UBS on Friday said that it has ended a 9 billion Swiss franc ($10.27 billion) loss protection agreement and a 100 billion Swiss franc public liquidity backstop that were put in place by the Swiss government when it took over rival Credit Suisse in March.
UBS said the decision followed a “comprehensive assessment” of Credit Suisse’s non-core assets that were covered by the liquidity support measures.

“These measures, together with the intervention of UBS, contributed to the stabilization of Credit Suisse and financial stability in Switzerland and globally,” UBS said in a statement.
Credit Suisse has also fully repaid an emergency liquidity assistance plus (ELA+) loan of 50 billion Swiss francs obtained from the Swiss National Bank in March, as the lender teetered on the brink after a collapse in shareholder and investor confidence, UBS confirmed.
“These measures, which were created under emergency law to preserve financial stability, will thus cease to exist, and the Confederation and taxpayers will no longer bear any risks arising from these guarantees,” the Swiss government said in a statement Friday.
“Furthermore, the Confederation earned receipts of around CHF 200 million on the guarantees.”
The Swiss Federal Council plans to submit a bill in parliament to introduce a public liquidity backstop (PLB) under ordinary law, while work continues on a “comprehensive review of the too-big-to-fail regulatory framework.”

The 9 billion Swiss franc LPA was intended to insure UBS on losses above 5 billion Swiss francs following the takeover, which was brokered over a frenetic weekend in March amid talks with the Swiss government, the SNB and the Swiss Financial Market Supervisory Authority.
The emergency rescue deal saw UBS acquire Credit Suisse for a discount price of 3 billion Swiss francs, creating a Swiss banking and wealth management behemoth with a $1.6 trillion balance sheet.
“After reviewing all assets covered by the LPA since the closing in June and taking the appropriate fair value adjustments, UBS has concluded that the LPA is no longer required,” UBS said.
“Therefore, UBS has given notice of voluntary termination effective 11 August 2023. UBS pays a total of CHF 40 million to compensate the Swiss Confederation for the establishment of the LPA.”
The 100 billion Swiss franc public liability backstop was established on March 19 by the Swiss government and allowed the SNB to provide liquidity support to Credit Suisse if needed, underwritten by a federal default guarantee.
UBS confirmed on Friday that all loans drawn under the PLB were fully repaid by Credit Suisse by the end of May, and that the group had terminated the PLB agreement after a review of its funding situation.
“Through 31 July 2023, Credit Suisse expensed a commitment fee and a risk premium totaling CHF 214 million, including approximately CHF 61 million to the SNB and CHF 153 million to the Swiss Confederation,” UBS added. More

The Biden administration’s long-awaited executive order on U.S. investments in Chinese companies leaves open plenty of questions on how it will be implemented.
Its 45-day public comment period gives U.S. investors significant potential to influence any final regulation, analysts said.
But the industry and political developments mark a shift in the overall risk environment.

The U.S. and Chinese flags hang outside the Goldman Sachs headquarters in New York on Dec. 16, 2008.
Chris Hondros | Getty Images News | Getty Images

BEIJING — The Biden administration’s long-awaited executive order on U.S. investments in Chinese companies leaves open plenty of questions on how it will be implemented.
Its 45-day public comment period gives U.S. investors significant potential to influence any final regulation, analysts said.

“The executive order obviously gives an outline of what the program’s scope is going to be like,” said Brian P. Curran, a partner, global regulatory at law firm Hogan Lovells in Washington, D.C.
“It’s not even a proposed rule. It’s not a final rule.”
U.S. President Joe Biden on Wednesday signed an executive order aimed at restricting U.S. investments into Chinese semiconductor, quantum computing and artificial intelligence companies over national security concerns.
Treasury Secretary Janet Yellen is mostly responsible for determining the details. Her department has published a fact sheet and a lengthy “Advance Notice of Proposed Rulemaking” with specific questions it would like more information on.

Businesses can share information confidentially as needed, according to the advanced notice, which is set to be formally published on Monday. The notice said it is only a means for sharing the Treasury’s initial considerations, and will be followed by draft regulations.

“The final scope of the restriction, to be defined by the Treasury Department after public consultations, including with U.S. investors in China, will be critical for the enforcement of the order,” said Winston Ma, an adjunct professor at NYU Law and a former managing director of CIC.

So what’s banned?

This week’s announcements don’t explicitly prohibit U.S. investments into Chinese businesses, but the documents indicate what policymakers are focused on.
The U.S. transactions potentially covered include:

Acquisition of equity interests such as via mergers and acquisitions, private equity and venture capital;
Greenfield investment;
Joint ventures;
Certain debt financing transactions.

The forthcoming regulations are not set to take effect retroactively, the Treasury said. But the Treasury said it may request information about transactions completed or agreed to since the issuance of the executive order.
“We’ve been advising clients leading up to the issuance of the executive order, it does make sense to look at your exposure to the kinds of transactions that have the potential to be covered by the regime,” Curran said.
Any plans to invest in the sectors named in the public materials should come under additional consideration of the risks and how to manage them, he said.

Here are the sectors of concern:
Semiconductors — Treasury is considering a ban on tech that enables production or improvement of advanced integrated circuits; design, fabrication and packaging capabilities for advanced integrated circuits; and installation, or sale to third-party customers, of certain supercomputers.
Treasury is also considering a notification requirement for transactions involving the design, fabrication and packaging of other integrated circuits.
The U.S. government is concerned about tech that will “underpin military innovations,” the advance notice said.
Quantum computing — Treasury is considering a ban on transactions involving the production of quantum computers, sensors and systems.
However, the Treasury said it is considering not to require investors to notify it of transactions in this sector.
The U.S. government is concerned about quantum information technologies that could “compromise encryption and other cybersecurity controls and jeopardize military communications,” the notice said.
Artificial intelligence — Treasury is considering a ban on U.S. investments into the development of software using AI systems designed for exclusive military, government intelligence or mass-surveillance use.
The Treasury said it may also require U.S. persons to notify it if undertaking transactions involved with AI systems for cybersecurity applications, digital forensics tools, control of robotic systems and facial recognition, among others.
However, the Treasury said its intent is not to touch entities that develop AI systems only for consumer applications and other uses that don’t have national security consequences.

What’s allowed

The Treasury said it expects to exclude certain investments into publicly-traded securities or exchange-traded funds.
The following transactions are not set to be included by forthcoming regulation:

University-to-university research collaborations
Contracts to buy raw materials
Intellectual property licensing
Bank lending and payment processing
Underwriting
Debt rating
Prime brokerage
Global custody
Stock research

What’s next

The Treasury is asking for written comments on its advanced notice by Sept. 28.
The notice includes wide-ranging requests for data into investment trends. It also asked questions about effective threshold requirements and definitions, and details about the resulting burdens for U.S. investors: “If such limitations existed or were required, how might investment firms change how they raise capital from U.S. investors, if at all?”
Among the many other questions, the Treasury is asking for areas within the three overarching categories where U.S. investments into Chinese entities would “provide a strategic benefit to the United States, such that continuing such investment would benefit, and not impair, U.S. national security.”
“There is a lot of opportunity for the public’s comment for what should be covered what should not be covered,” said Anne Salladin, a partner, global regulatory, at Hogan Lovells. “It strikes me as an extraordinarily good opportunity for clients to weigh in on that front.”
“This has been under consideration by the administration for a couple of years now,” she said. “One of the things that’s important is to take [the regulatory process] at a slow speed to understand what the ramifications are for U.S. businesses.”

The kind of law that Biden’s [planning], it’s small but it’s important because once the state starts to meddle with these things it creates more dramatic possibilities.

Jonathan Levy
Professor, University of Chicago

Given the lengthy process, forthcoming regulations aren’t expected to take effect until next year.
However, the niche industry of China-based venture capitalists — which raise funds from U.S. investors to invest in Chinese start-ups, many tech-focused — is already struggling.
Fewer than 300 unique U.S.-based investors have participated in China-based VC deals since 2016 each year, with just 64 participants so far this year, according to Pitchbook.
China VC deal activity in the second quarter continued a recent decline, to the lowest since the first quarter of 2017, according to Pitchbook.
The data showed China VC deal activity with U.S.-only investor participation in artificial intelligence has fallen since the first quarter of 2022. Pitchbook recorded barely any such deals in quantum computing since 2021, while semiconductors saw moderate activity through the first half of this year.

Read more about China from CNBC Pro

The industry and political developments also mark a shift in the overall risk environment.
“The kind of law that Biden’s [planning], it’s small but it’s important because once the state starts to meddle with these things it creates more dramatic possibilities,” said Jonathan Levy, a University of Chicago economic history professor and author of “Ages of American Capitalism: A History of the United States.”
While he said he doesn’t have any sources within the Biden administration, Levy said the latest developments signal to him that the U.S. government doesn’t want the new economic relationship with China “to consist of U.S. investment funds investing in Chinese high tech because we think high tech is kind of a strategic interest.”
“I also think more fundamentally, I don’t know what kind of relationship they have in mind, [but] there’s going to be a new order. We want to shape to some degree what that [order] looks like.”
— CNBC’s Amanda Macias contributed to this report. More

Employees prepare a window display at a Kate Spade store in The Shoppes at Marina Bay Sands shopping mall in Singapore, June 19, 2020.
Roslan Rahman | AFP | Getty Images

Check out the companies making headlines during midday trading Thursday.
Disney — Shares of the media giant jumped 5.3%. Late Wednesday, the company said it would raise the price on its ad-free streaming tier in October and that it would crack down on password sharing. Disney reported a 7.4% decline in subscriber count last quarter, however. It also recorded $2.65 billion in one-time charges and impairments, dragging the company to a rare quarterly net loss.

AppLovin — Shares popped more than 24.1% on Thursday. On Wednesday, the game developer posted solid second-quarter results and shared stronger-than-expected revenue guidance for the current period. AppLovin said it anticipates revenue to range between $780 million and $800 million, ahead of the $741 million expected by analysts, per Refinitiv. Earnings for the recent quarter came in at 22 cents, versus the 7 cents anticipated.
Alibaba — U.S.-traded shares rose 4.3% Thursday after the Chinese company beat analysts’ expectations and posted its biggest year-over-year revenue growth since 2021. In the June quarter, the company posted revenue of 234.16 billion yuan versus 224.92 billion yuan expected, per Refinitiv.
Capri, Tapestry — Capri soared more than 55.4%, while luxury company Tapestry slid 16% during Thursday’s trading session. The moves come after Thursday’s announcement that Tapestry, which is behind the brands Coach and Kate Spade, is set to acquire Capri Holdings in a roughly $8.5 billion deal. Capri owns the Versace, Jimmy Choo and Michael Kors brands.
Wynn Resorts — Shares of the hotel and casino company climbed 3% after Wynn topped analysts’ estimates in its second-quarter results. Late Wednesday, the company reported 91 cents in adjusted earnings per share on $1.6 billion of revenue. Analysts surveyed by Refinitiv were expecting 59 cents per share on $1.54 billion of revenue.
Global Payments — The financial technology stock added nearly 3% after Jefferies upgraded the company to buy from hold, citing long-term margin expansion and revenue growth as consumer spending increases. The analyst assigned a price target of $145, which implies a 16.9% gain from Wednesday’s close.

Penn Entertainment — Shares dropped about 3.9% on Thursday. Truist downgraded shares to hold from buy in a note from Wednesday evening, citing uncertainty around the company’s partnership with Disney’s ESPN to relaunch its sports betting app.
Roblox — Shares of the gaming company added 3.2% after an upgrade to outperform from Wedbush. Analyst Nick McKay remains optimistic on Roblox’s long-term trajectory, even though the company recently missed analysts’ estimates on the top and bottom lines in the second quarter.
Fleetcor Technologies — Shares of the global business payments company popped 4.5%. Several Wall Street firms hiked their price targets on Fleetcor on Wednesday in response to the company’s top and bottom-line beat for the second quarter. Earlier this week, Fleetcor posted adjusted earnings of $4.19 per share on revenue of $948.2 million. Analysts polled by FactSet called for earnings of $4.17 per share on revenue of $945 million.
— CNBC’s Brian Evans, Hakyung Kim, Samantha Subin, Jesse Pound, Yun Li and Alex Harring contributed reporting. More

A shopper looking at Michael Kors handbags in Macy’s flagship store in New York.
Scott Mlyn | CNBC

Check out the companies making headlines before the bell:
Capri, Tapestry — Capri soared more than 57%, while Tapestry slid 3.2% in premarket trading. The moves come after luxury company Tapestry, which is behind the brands Coach and Kate Spade, announced Thursday it would acquire Capri Holdings in a roughly $8.5 billion deal. Capri owns the Versace, Jimmy Choo and Michael Kors brands. 

AppLovin — AppLovin shares popped 25.8% in early morning trading after the company posted strong second-quarter results and optimistic third-quarter revenue guidance. The game developer said it expects $780 million to $800 million in revenue for the third quarter, exceeding the $741 million expected by analysts. AppLovin reported earnings of 22 cents per share for the second quarter, while analysts expected 7 cents, according to Refinitiv.
Sonos — Sonos popped 5% after beating analysts’ expectations in its latest quarterly results. The wireless speaker maker reported a loss of 18 cents per share on revenue of $373 million for its fiscal third quarter. Analysts polled by Refinitiv had expected a 20 cent loss per share on revenue of $334 million. Sonos also raised its full-year EBITDA guidance.
Alibaba Group — The U.S. listed shares of Alibaba rose 3.8% after the Chinese tech company beat analysts’ expectations in its quarter ending June. It reported non-GAAP per-share diluted earnings of CNY17.37, more than the consensus estimate of CNY14.59, according to StreetAccount. It posted revenue of CNY234.16 billion, exceeding the CNY224.75 billion forecast. 
Wynn Resorts — Wynn Resorts gained 2.2% after exceeding expectations for its second quarter on the top and bottom lines. The casino operator posted adjusted earnings of 91 cents per share on revenue of $1.6 billion. Analysts polled by Refinitiv had anticipated 59 cents on revenue of $1.54 billion.
Walt Disney — Shares of the media giant gained about 2% in premarket trading after the company said it would raise the price on its ad-free streaming tier in October and that it would crack down on password sharing. Disney reported a 7.4% decline in subscriber count last quarter, however. It also recorded $2.65 billion in one-time charges and impairments, dragging the company to a rare quarterly net loss.

Trade Desk — Shares of the advertising technology company moved up less than 1% after a second-quarter report that beat expectations on the top and bottom lines. Trade Desk generated 28 cents in adjusted earnings per share on $464 million of revenue. Analysts surveyed by Refinitiv were expecting 26 cents per share on $455 million of revenue. The company also said it expected revenue of at least $485 million in the third quarter, above the $480 million projected by analysts.
Six Flags Entertainment — Shares slid 3% after Six Flags reported second-quarter earnings that missed estimates. The amusement park company reported earnings of 25 cents per share on revenue of $444.0 million. Analysts polled by Refinitiv had anticipated per-share earnings of 78 cents on revenue of $459.0 million.
Illumina — Illumina dropped 4.6% after reporting weaker-than-expected guidance. The DNA sequencing company surpassed expectations for the second quarter, but expects some weakness in the second half of the year because of a slow recovery in China and a more cautious consumer. Illumina forecasts full-year revenue to rise 1% year over year, lower than the 7.1% rise analysts polled by Refinitiv were anticipating. 
— CNBC’s Yun Li, Jesse Pound and Pia Singh contributed reporting More

Try a little, and it is never too hard to argue that the stockmarket looks risky and a crash must be coming. But in the long run such arguments are usually best ignored. Since 1900 American shares have posted an average real return of 6.4% a year. Over three decades, that would transform the purchasing power of $1,000 into $6,400. Bonds, the main alternative, do not come close. With an average historical return of 1.7% a year, they would generate a measly $1,700. Cash would do worse still.The lesson for today’s investors, many of whom were caught out by this year’s bull market, might seem obvious. Forget about a downturn that may or may not materialise. Just buy and hold stocks, and wait for returns that will erase any number of brief dips. Unfortunately, there is a catch. What matters today is not historical returns but prospective ones. And on that measure, shares now look more expensive—and thus lower-yielding—when compared with bonds than they have in decades.Start with why stocks tend to outperform bonds. A share is a claim on a firm’s earnings stretching into the future, which makes returns inherently uncertain. A bond, meanwhile, is a vow to pay a fixed stream of interest payments and then return the principal. The borrower might go bust; changes to interest rates or inflation might alter the value of the cash flows. But the share is the riskier prospect, meaning it needs to offer a higher return. The gap between the two is the “equity risk premium”—the 4.7 percentage points a year that stocks have historically earned over bonds.What of the next few years? Estimating the return on a bond is easy: it is just its yield to maturity. Gauging stock returns is trickier, but a quick proxy is given by the “earnings yield” (or expected earnings for the coming year, divided by share price). Combine the two for ten-year Treasury bonds and the s&p 500, and you have a crude measure of the equity risk premium that looks forward rather than back. Over the past year, it has plummeted (see chart).Now consider the equity risk premium’s moving parts: earnings, Treasury yields and share prices. Both expected earnings and Treasury yields are roughly where they were in October, when share prices hit a trough. But since then shares have risen a lot, shrinking their earnings yield and bringing it closer to the “safe” Treasury yield. This might mean three things. Investors might believe earnings are about to start growing fast, perhaps because of an ai-fuelled productivity boom. They might think earnings have become less likely to disappoint, justifying a lower risk premium. Or they might fear that Treasuries—the benchmark against which stocks are measured—are now more risky.Sustained earnings growth is the dream scenario. The second option, though, is less rosy: that investors have let their revived animal spirits get ahead of them. Ed Cole of Man Group, an asset manager, argues the squeezed equity risk premium is a bet on a “soft landing”, in which central bankers quash inflation without a recession. This has become easier to envisage as price rises have cooled and most countries have so far avoided downturns. Yet surveys of manufacturers still point to recession in that sector, and the full dampening effect of rate rises may not yet have been felt. The third possibility is that, rather than cooing over stocks, investors are shunning the alternative. Last year was the worst for bonds in both America (where they lost 31% in real terms) and across developed markets (a 34% loss) in over a century.After that, says Sharon Bell of Goldman Sachs, a bank, it is unsurprising if some investors are wary of bonds and inclined to splurge on shares, especially if they believe inflation has moved structurally higher—something shares, as claims on nominal earnings, protect against, whereas bonds, deriving value from fixed coupons, do not. At the same time, governments are set to issue ever more debt to cover ageing populations, defence spending and cutting carbon emissions, while central banks have disappeared as buyers. Higher bond yields, and a mechanically lower equity risk premium, will be the result. This would imply a regime change, to one where the equity risk premium has shifted lower for the long term (rather than temporarily, to be corrected by a fall in share prices). Whatever the reason for the squeeze, investors have now placed their bets on rising profits. In a recent analysis, Duncan Lamont of Schroders, an investment firm, compared returns on the s&p 500 going back to 1871 with the yield gap against ten-year Treasuries. He found the relationship “has not been helpful in giving a steer on short-term market movements”. Over the longer term, though, there is a clear link. For stocks starting with a low yield gap to do well over ten years, “a near-condition has been real earnings growth”. Animal spirits can only take you so far before earnings must deliver. They would not have to slip far for even a long-term investor to conclude today’s market is too pricey. ■For more expert analysis of the biggest stories in economics, finance and markets, sign up to Money Talks, our weekly subscriber-only newsletter. More