Investors Are Making Big AI-Based Sentiment Bets

The Role of Sentiment in Shaping AI-Driven Stock Market Valuations

In recent years, the stock market has seen a surge in valuations driven not by fundamental analysis but by investor sentiment. This trend is particularly pronounced in the AI sector, where optimism and overconfidence are steering market dynamics. Four tech giants—Amazon, Alphabet, Microsoft, and Meta—have announced a 45% increase in capital expenditures, reflecting their bullish outlook on AI. Despite this, the broader market, such as the S&P 500, has shown modest declines, indicating a disconnect between sector-specific optimism and overall market performance.

Amazon as a Case Study: Dissecting Fundamental Value vs. Market Sentiment

Amazon serves as a prime example to examine the interplay between psychological biases and fundamental valuations. The company’s fundamental value hinges on its ability to generate cash flows for shareholders and debtholders. Sell-side analysts, such as those from UBS, employ free cash flow analysis to estimate Amazon’s stock valuation. As of February 2025, Amazon’s stock closed near $210, with UBS setting a target price of $230, suggesting a positive yet cautious outlook.

The Long-Term Focus and the Impact of Capital Expenditures

A critical insight from the UBS analysis is that 80% of Amazon’s stock value is attributed to projections from 2025 onwards. This underscores the importance of long-term investments, particularly capital expenditures, in shaping future cash flows. Amazon’s planned capex increase highlights the company’s commitment to growth, but it also introduces uncertainty. Investors must consider how these expenditures will influence long-term profitability and, consequently, stock valuations.

Analyzing Forecast Accuracy: Overestimation and Market Irrationality

The UBS team’s forecasts for Amazon’s free cash flows from 2020 to 2024 reveal significant overestimation, with actual flows being a quarter of the predicted amounts. Despite this, Amazon’s stock price in early 2025 exceeded the UBS valuation by 63%. This disconnect suggests that market sentiment, rather than fundamentals, is driving valuations. Such a divergence is unlikely in a rational market, pointing to the influence of psychological biases among investors and analysts.

Unrealistic Assumptions and the Role of Sentiment Surge

The overestimation of free cash flows can be attributed to underestimating capex, with analysts assuming a decline in Amazon’s property, plant, and equipment—an unrealistic scenario given Amazon’s expansionist strategy. This bias likely stems from a desire to present a more optimistic valuation. Additionally, the surge in tech stocks beginning in 2017, fueled by hype around companies like Amazon, has amplified investor sentiment. While Amazon is a solid company, investor enthusiasm has driven its stock performance beyond its fundamental value.

Conclusion: Navigating the Intersection of Sentiment and Fundamentals

Investors must recognize that returns on stocks like Amazon depend on both future sentiment and fundamentals. The current AI-driven optimism, coupled with substantial capex, suggests that market sentiment will continue to play a significant role. As such, investors should critically assess their reliance on sustained optimism and balance it with fundamental analysis to make informed decisions.