The Nasdaq Keeps Hitting New Highs. Don’t Be Tempted to Buy Big Tech.

Nvidia stock is a large component of the Nasdaq Composite index, which closed at a new record Friday. (THOMAS SAMSON/AFP via Getty Images)

The Nasdaq Composite’s rally seems unstoppable, but the technology-heavy index is starting to look a bit too hot.

The Nasdaq ’s rally this year brings it to a 95% gain in the past five years, about four percentage points better than the S&P 500 . It notched a fresh high Friday, its 18th record close of the year.

The artificial intelligence boom has been a key factor in tech’s stock market dominance. AI services and products have driven companies’ double-digit annual earnings growth in percent terms. Tech stocks have remained resilient amid President Donald Trump’s lofty tariffs and elevated interest rates.

But tech’s perseverance has also created hefty valuations, making significant further gains unlikely in the near term. The Nasdaq’s higher price-to-earnings multiple means the index is also more vulnerable to a pullback—especially if economic challenges start weighing on the sector’s earnings outlook.

The Nasdaq trades at just over 28 times analysts’ expected earnings, in aggregate, for the coming 12 months. That’s near its high of just under 29 times since early 2022, when the Federal Reserve began lifting rates. That’s when the entire equity market reassessed what were sky-high multiples before 2022, and realized that if higher rates would be here to stay, stocks would be far less valuable.

The fact that the Nasdaq’s multiple is nearing its high since early 2022 is partly why Sevens Report’s Tom Essaye writes that he’s on “AI bubble watch.” An AI bubble would also be a Nasdaq bubble, given that AI stocks account for many trillions of dollars of the index’s market value. Nvidia alone makes up 12.7% of it.

The Nasdaq’s current multiple is also 22% above the 22.9 times for the Russell 2000, an index of smaller, lower-quality, and less-loved stocks. That premium is much larger than the five-year average of 5.4%, according to our calculations of FactSet data. The Nasdaq’s valuation premium versus the Russell 2000 has rarely gone a touch above 30% during this time period. With the Nasdaq already trading at such a large premium, its multiple likely can’t rise much more from here—especially if the Russell’s multiple stops rising, as it has over the past few months.

Even if these stocks aren’t in a bubble, the Nasdaq has already priced in much of its future earnings, but not much of the risk to profits. That’s why the index could fall from its current pedestal.

Indeed, there are risks for the seemingly invincible sector. It’s true that software companies don’t have much exposure to rising costs from tariffs, and many semiconductor makers are exempt from levies altogether. But AI and the tech stocks aren’t entirely immune from economic challenges. There are several that could disrupt the Nasdaq’s surge.

Tariffs rates rose in July, so the resulting inflation and interest-rate levels could soon cause consumers to pull back on spending. Eventually, companies might respond by tightening their budgets, which includes software spending. That could, in turn, reduce chip demand from software providers such as Microsoft and Alphabet. Demand for chips that go into cars and industrial machinery could suffer, too. iPhone demand could conceivably weaken and pressure Apple’s stock—especially because the company hasn’t yet hammered out a clear AI strategy for its smartphones.

Any of these factors coming to fruition would reduce earnings expectations for tech, causing the Nasdaq to drop.

In fact, the index’s gains are already slowing down. The Nasdaq was up 4.3% in the past month through Thursday, versus 4.5% in the month of trading ended July 7, and 10% in the month before that. Tech stocks rallied 13% in the month of trading ended May 6, as they recovered from an April drop on the back of Trump’s initial tariff announcement. Essentially, buying interest in tech has waned each month as these stocks have become more expensive. They have far less juice to move higher versus a few months ago.

The next major event for the Nasdaq is Nvidia’s earnings, on Aug. 27. The company usually beats analysts’ earnings estimates, but that doesn’t mean the stock, and other chip names, will soar.

Nvidia shares are already reflecting high earnings growth, so the chipmaker’s results likely need to surpass expectations by a lot for the stock to gain. For the past four quarterly reports, Nvidia stock dropped twice on the trading day after earnings, with an 8.5% fall in the quarter reported in February.

Sluggish performance for the AI chip leader could mean the same for its peers’ stocks, such as Advanced Micro Devices , Broadcom, Micron Technology, and Marvell Technology, which combine for just over $6 trillion of market value, or 18.3% of the Nasdaq.

The takeaway: Don’t buy tech stocks here. Let them cool off first.

Write to Jacob Sonenshine at jacob.sonenshine@barrons.com