Valuation expert Aswath Damodaran says investors cannot sit out the artificial intelligence debate and must pick one of four strategies: bet on AI's success, follow market consensus, stay sceptical, or position for a crash.
He set out the framework in his latest blog post, as the US market keeps rallying despite a sharp rise in bond yields.
A Rally Against The Odds
Damodaran wrote that September 2026 was a record-setting month for US markets. The 10-year Treasury yield jumped from 4.75% to 5.29%, a 54 basis point rise that ranks in the top 10% of monthly moves since 1962. Even so, US stocks added $2.5 trillion in market value, almost $1.5 trillion of it from technology.
Earnings, Not Optimism
He attributed the resilience to earnings. Net income at US companies rose 57% year on year in the second quarter of 2026, to $904 billion, and forecasts for 2027 and 2028 have been raised.
His implied equity risk premium fell to 3.70%, below 4% for the first time this year, as the expected return on stocks climbed to 8.99%. The rally is narrow, though. Nearly 65% of listed stocks fell in the third quarter.
ALSO READ | Bessent Will Likely Cut US Long Bond Sales Next Month, Says Citi
The Capex Question
The driver, Damodaran said, is AI spending. Capital expenditure at US listed companies reached $133.4 billion in the second quarter, up almost 36%, with growth above 50% in technology, communication services and consumer discretionary.
Book equity in technology rose about 30% against a debt increase of 18.8%. He cautioned that accounting earnings are not free cash flow. Companies returned only about 63% of earnings to shareholders over the past year, the lowest since 2004.
The Four Strategies
Damodaran said the first option is to back AI as a transformative force by buying its developers and avoiding or shorting businesses at risk of disruption. The second is to accept the market's view through index funds tracking the S&P 500. The third is to doubt that AI's returns justify current valuations and favour less exposed sectors such as food processing and leisure.
The fourth is to cut equity exposure in anticipation of a crash, though he warned that betting against the boom has not paid for most investors in two years.
What He Is Doing Himself
Damodaran said he holds five of the Magnificent Seven, including Amazon, Alphabet, Meta Platforms and Microsoft. Most of his fresh money over the past year or two has gone into cash and short-term
Treasuries yielding about 4%. He acknowledged that this has left gains on the table but said it helps him sleep. His advice to investors is to find a path that passes the same sleep test.
The Risk
In the best case, he wrote, AI builders earn returns above their cost of capital. In the worst, write-offs and defaults follow, and markets will price them before accountants do.
ALSO READ | AI Trade's Weak Link Isn't Chips, It's Debt: Who Is Most Exposed If Yields Keep Climbing
Essential Business Intelligence, Sharp Market Insights, Practical Personal Finance Advice, Daily Fuel, Gold and Silver Prices and Latest Stories — On NDTV Profit.