This year's tech-led market rally is showing some signs of cooling. The tech-heavy Nasdaq Composite has declined nearly 1% since June 16. While it's debatable whether this signals that the Nasdaq Composite's strong momentum this year could take a breather for a while, one thing is likely: The index's 29% year-to-date rally has likely led to some stocks getting ahead of themselves.
There are certainly some Nasdaq-traded growth stocks looking stretched. Indeed, two of the most popular stocks of 2023 -- Tesla (TSLA -1.11%) and Nvidia (NVDA 6.18%) -- may have risen to the point that it may be wise to avoid them.
Electric car maker Tesla and graphics chip maker Nvidia have seen their stocks soar about 113% and 195% year to date respectively, leaving their valuations appearing stretched. This has led analysts to share some words of caution regarding both stocks this week. It may be worth investors' time to listen to what they have to say.
Valuation matters
Morgan Stanley analyst Adam Jonas said in a note to investors on Thursday morning that the market's rosy expectations, fueled by a growing appreciation for artificial intelligence (AI), have driven Tesla stock to levels that make it no longer attractive. However, the analyst doesn't think it's time to sell. He changed his rating on the stock from overweight to equal weight -- a rating that is similar to a hold rating.
This followed Barclays analyst Dan Levy's move on Wednesday to downgrade Tesla stock from buy to hold. Despite increasing his 12-month price target from $220 to $260, the stock's strong appreciation this year still makes shares a hold instead of a buy at their current level, Levy argues.
Noting that Tesla has had to cut prices of its vehicles this year to drive its sales growth, Levy believes the market's bullish view for the stock may risk underappreciating the company's near-term challenges. Like Jonas, Levy also thinks the market's optimism for AI has become too exuberant. Sure, recent progress in artificial intelligence may increase the odds of Tesla rolling out autonomous driving technology in the coming years. But the market's optimism about this side of the automaker's business may simply be too great.
Regarding Nvidia, Lynx analysts KC Rajkumar and Jahanara Nissar said they think the market's expectations for data center sales next year are far too high. The market's euphoric expectations for AI's effect on companies like Nvidia have made them bearish on the stock.
It's OK to watch from the sidelines
Investors should tread carefully when it comes to the difference between appreciating a powerful tailwind like AI and becoming overly optimistic about it. Investors should carefully consider both the positive effects of AI and the risks of market expectations becoming too high. Given Tesla and Nvidia stocks' sky-high valuations, the risks for investors are particularly high over the long term. It's extremely difficult to predict technological winners, let alone how that technology will translate to profits over the long haul.
Fortunately, investors don't have to invest in the most hyped stocks of 2023. With Tesla and Nvidia boasting market caps of about $830 billion and $1.1 trillion and their price-to-earnings ratios sitting at 75 and 223, respectively, these stocks may be priced for perfection. With valuations like this, it may be a good time for investors to fish elsewhere, looking for underappreciated and overlooked investments instead.
Remember: It's OK to watch from the sidelines. When valuations of particular stocks become questionable, there's no reason investors should feel like they have to participate.
