NYU's Damodaran Warns of Market Corrections

Concerns are rising about the sustainability of the current market rally, fueled by a handful of mega-cap technology companies, with NYU Stern Professor Aswath Damodaran warning in a Bloomberg interview last week that the market’s "priced for perfection" trajectory is unsustainable and likely to lead to a correction.

"You cannot have back-to-back years like 2023 and 2024 and not expect something to be fixed leading into 2025," he stated, emphasizing the precarious nature of the current market environment.

He differentiated between the "pricing game," driven by market mood and momentum, and the "investing game," focused on underlying financial performance. Currently, he asserts, the market is heavily influenced by the former, where fundamentals are largely ignored. Damodaran noted the alarming concentration of market gains, with the magnificent seven accounting for a disproportionate share of overall growth. These companies, he pointed out, represent a market capitalization so large that if considered independently, they would comprise the second-largest equity market globally.

While acknowledging the impressive performance and profitability of these tech giants, particularly Nvidia's exceptionally high profit margins, Damodaran cautioned against the current inflated valuations. He highlighted Nvidia's reliance on the burgeoning AI market, emphasizing that the company's success hinges not just on the demand for its chips, but crucially on the ability of other companies to successfully monetize AI-based products and services built on Nvidia’s architecture.

Nvidia's current valuation hinges on a massive AI market, implicitly estimated at three to four trillion dollars, according to Damodaran.

"The test for Nvidia," he explained, "is going to be... whether [the companies buying Nvidia's chips] can turn out products and services that people are willing to pay for." This is because, while Nvidia dominates the AI chip market, their success is ultimately dependent on the ability of other companies, particularly the four big tech companies accounting for half of Nvidia's AI chip sales, to build profitable businesses on top of Nvidia's architecture.

These companies are investing heavily in AI infrastructure, but Damodaran points out a critical gap: "Right now I can't think of a single company that is actually making money on AI products and services," he said.

This disconnect between investment and profitability in the broader AI ecosystem, Damodaran suggests, poses a significant risk of a correction for Nvidia and potentially the wider market.