AI stocks may correct, but a 2000-style crash unlikely: Vincent Nichols

While it is a crowded trade, ironically, we aren't seeing much new money flowing into it recently, says Vincent Nichols, investment specialist, US and thematic equity, at BNP Paribas Asset Management

US smallcaps are a compelling value opportunity amid concerns about stretched valuations in artificial intelligence-linked stocks, says Vincent Nichols, investment specialist, US and thematic equity, at BNP Paribas Asset Management. The firm’s GIFT City venture has launched the Baroda BNP Paribas GIFT US Small Cap Fund, a feeder fund. Nichols, in an interview with Samie Modak in Mumbai, says US smallcaps — which have trailed largecaps through a prolonged earnings recession — are now seeing profits bottom out. Valuations are more attractive than those of their largecap counterparts. Edited excerpts: 

The US market has been doing well, largely driven by big tech. Do you see this continuing, or do you think the market has entered an expensive territory? 

There are two parts to that question. Regarding valuation, yes, by many metrics, the market looks rich. But that doesn't mean underperformance is imminent. Valuation is a poor predictor of near-term returns. As long as megacap tech companies continue investing heavily in capex and AI infrastructure, I expect the momentum to continue. There could be short-term corrections technically but a bubble burst like in 2000 seems unlikely. These companies invest in AI because it’s existential to their businesses, not solely for attractive returns. I believe the strength in tech could last a couple more years. 

AI has become a crowded trade globally. Is there still money flowing to this space? 

While it is a crowded trade, ironically, we aren’t seeing much new money flowing into it recently. Many investors already have large positions in US tech, mostly via passive or active management. Even our team has not seen significant inflows. Globally, there’s been pessimism about the US investment story but the market has proven resilient.

 

You mentioned the dotcom bubble earlier. How is the current tech environment different?

 

There are many differences. Valuations are nowhere near the dotcom bubble levels. Then, there was massive investment in infrastructure that often went unused — today, demand is outstripping supply, especially for data centres. Cloud services driven by AI show strong growth — Microsoft’s Cloud business grew around 40 per cent year over year. These companies finance capex with cash flow and manageable debt, unlike the overleveraged dot.com era. The average IPO valuation today is much lower than in 2020 and far below the dot.com bubble. The number of IPOs is also a fraction of what it was then. Private markets show more froth currently, which is an important distinction.

 

With all the focus on AI, are there undervalued sectors that investors overlook?

 

Absolutely. One area that’s received much less attention over the past five years is US smallcaps. The smallcap market is more diversified by sector, including industrials, financials, and healthcare, unlike the concentration in largecaps. Smallcaps have been in an earnings recession with earnings down over 35 per cent since 2022 but we’re starting to see a positive inflection. Plus, valuations in smallcaps are much more attractive compared to largecaps.

 

Given we are in a long cycle of largecap outperformance, do you see signs of an imminent shift toward smallcaps?

 

While the valuation differential is extreme, it has been so for years without triggering immediate outperformance. The key catalyst now is fundamental earnings growth, which is beginning to turn positively. Interest rate declines have helped ease financing costs for smaller companies, which are more sensitive to rates due to floating rate debt. Consensus expectations point to over 50 per cent earnings growth for smallcaps in 2026, which could start an extended outperformance cycle.

 

Within the smallcap space, are there particular themes or sectors that stand out?

 

Biotech is a major driver in smallcaps, recovering due to the easing interest rate environment. AI infrastructure also plays a strong role, not just in tech but across industrials, energy, and utilities. But it’s critical to construct balanced portfolios to avoid heavy reliance on AI themes, which can cause significant tracking error and volatility.

 

Are there exchange-traded funds (ETFs) or active funds tracking the smallcap space effectively?

 

Yes, many ETFs cover smallcaps. However, active management tends to generate alpha more easily in smallcaps than in large caps because the benchmarks are more diversified and less concentrated. The average weight of a smallcap stock in the Russell 2000 is around 14 basis points, compared to about 40 per cent for the top 10 in largecaps. This creates opportunities for active managers to differentiate through stock picking rather than relying on macro or sector bets.

 

What are your views on the US dollar?

 

I don't have a strong directional view. Currencies can remain inefficient and extended for long periods. The dollar depreciated in early 2025 but has since stabilised and remains in the middle of its range over the past five years.

 

How about the European market performance this year?

 

The euro’s strength has boosted European market returns in dollar terms this year. Infrastructure and autonomy themes have been strong in Europe. However, macroeconomic fundamentals like GDP and earnings growth have been weaker than in the US, which may limit sustained performance without stronger fundamentals backing it.