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Artificial intelligence is intriguing investors who are drawn to popular momentum stocks.Thinkhubstudio/iStockPhoto / Getty Images

After Nvidia’s share price jumped more than 24 per cent on Thursday, the combined value of the U.S. chip-designer’s shares approached US$1-trillion, putting the company among tech giants such as Apple Inc. AAPL-Q, Microsoft Corp. MSFT-Q, Google-parent Alphabet Inc. GOOG-NE and Inc AMZN-Q.

More importantly, the rally pushed artificial intelligence further to the forefront of investing themes – intriguing investors who are drawn to popular momentum stocks but raising concerns about the emergence of yet another equity bubble.

The impasse over the U.S. debt ceiling, fears about an oncoming recession and signs of an earnings slowdown mean little next to the promise of generative AI. Nvidia Corp.’s NVDA-Q breathtaking gains – its shares are now up more than 164 per cent since the start of the year – offer clear evidence of the theme’s potential.

“It’s clear the AI revolution is not going away and remains one of the most investable tech themes we have seen in decades despite the near-term macro backdrop with debt ceiling and recession worries front and centre,” Dan Ives, an analyst at Wedbush Securities, said in a note this week.

Tech stocks are popular again, even as the broader market sways.

Within the S&P 500, tech stocks have risen nearly 13 per cent over the past month alone, outpacing the broader index by more than nine percentage points. The tech-heavy Nasdaq Composite Index is up 9 per cent over this period, leading major indexes.

The last tech rally was driven by pandemic lockdowns, when many technology companies benefited from people working and shopping from home. The rally sputtered late last year as many companies slashed their payrolls amid a slowdown in growth.

But AI offers a compelling reason to jump back in. Tech stocks took off after OpenAI introduced ChatGPT to the mainstream in late 2022. Though AI raises questions about ethics and regulations, it also offers exciting new growth opportunities for some companies.

Nvidia – which is well known for its gaming graphics processors, but also makes the platforms for companies employing AI systems – provided a glimpse this week of the monetary potential here, and it clearly surprised investors.

Jensen Huang, Nvidia’s founder and chief executive officer, said in a statement that US$1-trillion worth of data-centre infrastructure – key to the company’s AI growth – will move toward “accelerated computing as companies race to apply generative AI into every product, service and business process.”

The part that jolted the stock: Nvidia said that revenue in the second quarter should rise to about US$11-billion, up 53 per cent from reported revenue in the first quarter and well above the average estimate from analysts prior to the company’s earnings report.

The stock’s gains this week, which added more than US$200-billion to Nvidia’s market capitalization, has driven the stock’s valuation to lofty levels.

According to Jim Kelleher, an analyst at Argus Research, Nvidia’s shares trade at about 51 times his profit estimate for fiscal 2024, marking a hefty premium over industry peers and the broader market.

Is that a problem? He doesn’t think so. He raised his target price on the stock – or where he expects it will trade within 12 months – to US$450. That implies another hefty gain from Friday’s closing price of US$389.46.

“Nvidia has become a much faster-growing company than it was over the preceding five years, and in our view deserves to trade at very rich premiums to peers and to its own historical valuations,” Mr. Kelleher said in a note.

Another point in the stock’s favour: Analysts at Credit Suisse earlier this week noted that the largest active U.S. fund managers have been shunning many of the largest tech stocks this year.

Apple, Tesla Inc. TSLA-Q, Nvidia, Amazon and Microsoft had a combined weighting of 19.6 per cent within the S&P 500, at the end of March. But the respective weighting of these stocks within the largest mutual-fund portfolios lagged at just 13.8 per cent, according to Credit Suisse.

This underweighting suggests that professional investors are not yet stampeding toward the tech sector, which could point to further gains as the AI promise turns to actual sales.

Chasing trends can be dangerous, of course, when those trends begin to fade.

Despite an encouraging comeback this year, Shopify Inc.’s SHOP-T share price is down 65 per cent from its record high in 2021. Similarly, Tesla, the electric carmaker, has lost about half its value over the same period.

The downside risk with Nvidia is that investors are chasing one of the few good stories to emerge this year, setting up the possibility of disappointment later on.

The hope, though, is that AI’s peak as an investing theme is still years away. It’s easy to dismiss a pricey, popular stock – but Nvidia’s spectacular outlook for revenue growth lends a lot of support to the bullish case.

Follow David Berman on Twitter: @dberman_ROBOpens in a new window

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