Reviewing the "Five Bubble Indicators," Goldman Sachs believes "the current situation resembles 1997 rather than 1999, and the AI bull market still has a second half."

For investors closely watching whether the AI-driven surge in U.S. stocks has entered a bubble zone, Goldman Sachs has provided a clear answer: It is not a bubble yet, at least not at the level of the "macro bubble" seen in 1999-2000.

According to the Wind Trading Desk, on November 9th, Goldman Sachs released a report stating that the current macro fundamentals of the market resemble those of the mid-bubble years of 1997 or 1998, rather than the peak bubble year of 1999. The key imbalances that led to the eventual bursting of the bubble, such as widespread investment overheating, deteriorating corporate profits, and a sharp rise in leverage, have not yet appeared.

This means that despite high valuations, the AI-driven bull market may still have a second half. Exiting too early could result in missing out on substantial subsequent gains. However, risks are accumulating, and investors should begin to lay out hedging strategies. Unlike in 1999, the current market's credit spreads and volatility remain low, providing a more cost-effective window for investors to use tools like options for risk management.

Five Key Indicators of "Macro Bubble"

Goldman Sachs first clarified a point: simply high valuations do not equate to a "macro bubble." A true macro bubble, like the internet bubble of the late 1990s, involves not only severe overvaluation of asset prices but also macro imbalances that have a significant impact on the real economy. The report systematically reviewed five key macro and market characteristics from the 1990s:

Massive Investment Boom: By early 2000, the share of technology equipment and software investment in GDP soared from just over 3% in early 1995 to a record 4.5%. The total share of non-residential investment in GDP rose from about 11% in 1992 to nearly 15% in 2000.

Profitability Peaked and Declined: Despite continuous productivity improvements, corporate profit margins peaked at the end of 1997. A tight labor market pushed wages up, eroding corporate profits.

Leverage Rose Sharply: The surge in investment and decline in profits forced the corporate sector's financial condition from surplus to deficit, leading to a significant increase in corporate debt and a deterioration in balance sheet health.

External Crises Fueled Capital Inflows and Fed Rate Cuts: The Asian financial crisis and Russia's default in 1997-1998 led to a massive influx of capital from emerging markets into the U.S. To hedge against financial pressure, the Federal Reserve cut rates by 75 basis points at the end of 1998, further fueling the stock market.

Credit and Volatility Markets Issued Warnings: Starting in mid-1998, even as the stock market accelerated, credit spreads and Nasdaq volatility rose in tandem, reflecting that other asset markets had begun to reprice for risk.

Why the Current AI Boom Has Not Yet "Bubbled"?

The report compared the current AI boom with the five indicators mentioned above, concluding that signs of macro imbalance are far from reaching the levels seen in the late 1990s.

Investment has begun, but its scale and breadth are not comparable to that time: Although capital expenditures by "AI super giants" are expected to double since the release of ChatGPT, the share of AI-related investment in GDP is still far smaller than the peak of telecom investment in 2000The current investment boom is more moderate in terms of both duration and breadth.

Profitability remains solid: Currently, corporate profit margins are stable and show no signs of deterioration. Productivity has rebounded, while wage growth is slowing, leading to a significant decline in unit labor costs, which is in stark contrast to the situation in the late 1990s.

Financial conditions are relatively healthy, and leverage is controllable: Unlike the financial deficits faced by the corporate sector in the late 1990s, the current corporate sector is still in a state of financial surplus. Large technology companies primarily rely on free cash flow rather than debt to fund capital expenditures, and balance sheets are generally robust.

External environment is different, lacking catalysts for capital inflow: Although the current U.S. current account deficit is large, it remains stable and has not seen the massive net capital inflows driven by external crises as in the late 1990s.

Credit spreads and volatility remain low: Due to low corporate leverage, credit spreads are still at very narrow levels. The implied volatility in the equity market has also not shown sustained increases. The report states that the current levels of credit spreads and volatility resemble those of 1997, rather than 1999.

The party is still in 1997, but the turning point of 1998 is approaching

Overall, Goldman Sachs believes that the macro footprint of the current AI boom is fundamentally different from the late stage of the tech bubble in the 1990s (1999-2000) and shares more similarities with the early stage (1997-1998). The report points out that the contribution of AI to GDP growth is currently estimated at only 0.3 percentage points, which resembles the early stage of the tech boom in the 1990s.

However, the report keenly captures potential signals of a "1998-style" turning point:

Investment plans accelerating: The capital expenditure plans of AI giants and private companies indicate that AI-related investments will continue to grow rapidly.

Financial balance nearing a turning point: The financial surplus of the corporate sector is being eroded, approaching a deficit for the first time in 20 years. The balance sheet advantages of tech giants are no longer as pronounced as in the past.

Debt financing on the rise: The proportion of debt financing for data center investments is increasing, and the latest transactions in the AI field have also raised the demand for debt issuance, giving rise to complex arrangements similar to "vendor financing."

External funds and loose policies: The Federal Reserve has initiated a "preemptive" rate-cutting cycle; at the same time, foreign governments from the Middle East and Japan have announced investment commitments totaling over $4 trillion, which, if realized, could play a role similar to the external capital inflows of the late 1990s.

How to be "both offensive and defensive" in the second half of the AI bull market?

The report suggests that since the current market resembles 1997, it is dangerous to assert that a bubble exists and exit too early, as history shows this could lead to missing out on the most lucrative returns. However, valuations have already "moved further" than the macro fundamentals, and the market capitalization growth of AI-related companies has far exceeded their predicted present discounted value (PDV) of capital incomeTherefore, for investors, the key is how to strike a balance between continuing participation and risk prevention. The report provides specific recommendations:

Utilize options for "offensive and defensive conversion": Unlike the high credit spreads and volatility from 1998 to 2000, the current low volatility environment provides a good foundation for options strategies. Investors may consider using lower-cost call option structures to continue capturing upside potential while limiting downside risk.

Preemptively arrange risk hedging: History shows that even in bull markets, credit spreads can widen due to increased debt. Therefore, it is reasonable to position for a widening of credit spreads or an increase in long-term equity volatility over the next one to two years, which can serve as an effective hedge under the ongoing AI bull market.

Pay attention to the bidirectional risks in the interest rate market: If the AI investment boom continues, corporate financing demands will compete with government fiscal deficits for capital, potentially pushing up long-term interest rates. However, if the AI boom falters, historical experience shows that policy rates and long-term yields may ultimately decline significantly.

In summary, this report from Goldman Sachs paints a complex roadmap for investors: the AI party is not over yet, but savvy investors should start paying attention to changes in the music and be prepared to navigate the next phase of risks and opportunities