The enthusiasm about artificial intelligence (AI) has significantly propelled stock markets to record highs in 2023. However, this rapid ascent has also sparked fears of a potential market bubble. Since the launch of OpenAI's ChatGPT in 2022, the AI sector has become the dominant theme in financial markets, fostering widespread optimism among investors regarding a transformative AI boom. This optimism has led to unprecedented investments in technology stocks, pushing their valuations to historically high levels.
Many analysts are sounding alarms over these inflated valuations, suggesting that the market could be experiencing a bubble—characterized by investors bidding up stock prices beyond their actual worth. This situation often culminates in a significant downturn, reminiscent of the dot-com bubble that burst in 2000. Major technology firms, including Meta (META), Microsoft (MSFT), and Amazon (AMZN), have invested hundreds of billions of dollars in data centers and infrastructure to support AI initiatives, with plans for even more extensive spending.
Despite these impressive investments and earnings results that continue to please Wall Street, questions linger about the sustainability of the current market rally and the potential fallout if stock prices were to plummet. Kristalina Georgieva, Managing Director of the International Monetary Fund, highlighted this concern in a recent speech, stating, “Today’s valuations are heading toward levels we saw during the bullishness about the internet 25 years ago.” She cautioned that a sharp correction could lead to tighter financial conditions, adversely affecting global economic growth.
Concerns about a potential bubble have intensified as leading AI companies like Nvidia and OpenAI announced deals involving circular financing, raising suspicions that top players may be artificially propping up the market. According to strategists at Goldman Sachs, the surge in valuations and the emergence of circular financing echo patterns observed in previous financial bubbles. They noted, “While it appears we are not in a bubble yet, high levels of market concentration and competition in the AI space suggest investors should continue to focus on diversification.”
Notably, despite these concerns, anything related to AI continues to experience high demand. For instance, OpenAI's recent partnership with chip manufacturer Advanced Micro Devices (AMD) resulted in a nearly 24% surge in AMD's stock price. This rally has drawn parallels to the dot-com bubble; however, investors point out a crucial distinction: current big tech companies are reporting profitability and delivering strong earnings, unlike the unprofitable entities that characterized the 1990s tech bubble.
Eric Freedman, Chief Investment Officer at US Bank Asset Management, remarked, “Unlike the 1990s tech bubble that featured soaring stocks from unprofitable early-stage companies, strong mega-cap company earnings are driving this year’s rally.”
Mike Mullaney, Director of Global Markets Research at Boston Partners, described the current market sentiment as being in "bubble light" territory. He noted that while valuations, positioning, and flows indicate a potential bubble, investor sentiment has not yet reached the peak levels of exuberance that would signal immediate risk. Mullaney stated, “This thing could still run.”
The influence of big tech on the S&P 500 is growing, with AI-related stocks significantly contributing to the index's record highs. This growth has implications for individual investors, especially those with 401(k) retirement plans, as they stand to benefit from the gains but are also vulnerable to potential downturns if a bubble bursts. According to Howard Silverblatt, Senior Index Analyst at S&P Dow Jones Indices, 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.
The Bank of England recently warned that the risk of a sharp stock market downturn has increased, stating in a quarterly report that equity market valuations appear stretched, particularly for technology companies focused on AI. The report emphasized that the increasing concentration within market indices makes equity markets particularly vulnerable if expectations surrounding AI shift toward pessimism.
Reflecting on the past, in 1996, former Federal Reserve Chair Alan Greenspan famously questioned whether “irrational exuberance” was taking hold in financial markets. Greenspan's warnings came years before the dot-com bubble peaked in 2000. Recently, Federal Reserve Chair Jerome Powell echoed similar sentiments, suggesting that stocks are “fairly highly valued,” drawing comparisons to Greenspan’s comments from three decades ago.
Ed Yardeni, President of Yardeni Research, pondered whether the stock market is on a trajectory back toward the same irrational exuberance that inflated the Tech Bubble of 1999, which was followed by the Tech Wreck of the early 2000s. However, he noted, “The S&P 500 has been driven to new highs this year by better-than-expected earnings,” and expressed a target of 7,700 for the S&P 500 by the end of next year.
