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The craze for artificial intelligence has propelled markets to record levels this year. But this fierce rise has also raised fears of a bubble.
AI has been the dominant theme in the markets since 2022 when OpenAI first launched ChatGPT. Optimism has since spread among investors about a potential transformative AI boom, and huge sums of money have flowed into tech stocks. Valuations have reached historically high levels.
To some analysts, these are warning signs that the market may be in a bubble – when investors drive up stock prices beyond their value, creating an unsustainable rally that often results in a significant downturn, as seen when the dot-com bubble burst in 2000.
Big tech companies like Meta (META), Microsoft (MSFT), and Amazon (AMZN) have spent hundreds of billions of dollars on data centers and infrastructure to develop and power AI, and have set aside hundreds of billions of dollars for additional spending.
The results of these companies continue to impress Wall Street, supporting high valuations and the stock rally. Yet concerns are growing about its sustainability and the possible consequences of a significant drop in stocks.
“Encouraged by optimism about AI’s productivity-enhancing potential, global stock prices are soaring,” Kristalina Georgieva, managing director of the International Monetary Fund, said in a speech Wednesday.
“Current valuations are heading toward the levels we saw during the Internet bull market 25 years ago,” Georgieva said. “If a sharp correction were to occur, a tightening of financial conditions could weigh on global growth.”
Concerns about a potential bubble have intensified in recent weeks when AI stars like Nvidia and OpenAI announced circular financing deals that raised eyebrows that major players could prop up the market.
Rising valuations and the emergence of circular financing are among the aspects that “rhyme with previous bubbles,” according to Goldman Sachs strategists.
“While it appears we are not yet in a bubble, the high levels of market concentration and competition in the AI space suggest investors should continue to focus on diversification,” the strategists said in a note.
Despite concerns, anything related to AI is in high demand. OpenAI announced a new deal with chip company Advanced Micro Devices (AMD) on Monday, sending AMD shares up nearly 24%.
The rally has drawn comparisons to the dot-com bubble. However, investors have pointed out that there is a key difference: Big tech companies are now actually profitable and generating strong results.
“Unlike the tech bubble of the 1990s, which saw shares of unprofitable early-stage companies soar, strong profits at ultra-large-cap companies are driving this year’s rally,” Eric Freedman, chief investment officer at US Bank Asset Management, said in a note.
Mike Mullaney, director of global markets research at Boston Partners, said the market signals “bright bubble” territory. He said investor sentiment has not yet reached exuberance levels that would indicate the market is at its maximum risk level.
“The valuations, positioning and flows certainly indicate that we are in a mild bubble zone, but the sentiment is just not there yet,” Mullaney said. “And so this thing could still work.”
The growing influence of AI on the S&P 500
Big Tech has an increasingly influential place in the S&P 500 index, weighted by companies’ market value. As AI-related stocks have driven the market to record highs, they have also become a larger part of people’s 401(k) retirement plans.
While the rapid growth of technology stocks allows individual investors and people saving for retirement to share in company gains, it leaves individuals vulnerable to a potential prolonged withdrawal if a bubble bursts.
Just seven stocks – Alphabet (GOOG), Amazon, Apple (AAPL), Meta, Microsoft, Nvidia (NVDA) and Tesla (TSLA) – have accounted for 55% of the S&P 500’s gains since the end of 2022, according to Howard Silverblatt, senior index analyst at S&P Dow Jones Indices.
The Bank of England said on Wednesday that the risk of a sharp fall in the stock market had increased.
“Across a number of measures, equity market valuations appear stretched, particularly for technology companies focused on artificial intelligence,” the bank said in a quarterly report.
“This, combined with increasing concentration within stock indices, leaves equity markets particularly exposed if expectations about the impact of AI become less optimistic,” the bank said.
In 1996, Alan Greenspan, then chairman of the Federal Reserve, asked whether “irrational exuberance” was taking hold in financial markets.
While Greenspan warned that the stock market might be too emotionally driven, the peak of the dot-com bubble didn’t occur until four years later, in 2000.
Federal Reserve Chairman Jerome Powell said on September 23 that stocks were “pretty highly valued,” drawing comparisons to his predecessor’s comments 30 years ago.
Ed Yardeni, president of Yardeni Research, said in a note: “Is the stock market back on the path to the same irrational exuberance that inflated the tech bubble of 1999, which was followed by the tech wreck of the early 2000s? Maybe. »
“However, the S&P 500 Index has reached new highs this year on better-than-expected earnings,” Yardeni said. “We still aim for the S&P 500 to reach 7,700 by the end of next year.”
