The narrative has been intoxicating. For the past 18 months, the stock market has been drunk on the promise of artificial intelligence. Every earnings call, every product launch, every CEO interview has been laced with the same buzzword. And the market has lapped it up, driving the valuations of a handful of tech giants to levels that would make a Victorian railway speculator blush.
But the hangover may be imminent. This week's wobbles in the Nasdaq, triggered by a surprisingly cautious outlook from a major chipmaker, have sent a shudder through the City. The question is no longer whether we are in a bubble. The question is whether it has already started to deflate.
Let us look at the numbers. The so-called 'Magnificent Seven' now account for a disproportionately large share of the S&P 500's market capitalisation. Their price-to-earnings ratios, even after adjusting for growth, are historically elevated. We are paying a premium for a future that may not arrive as quickly or as profitably as the bulls assume.
Consider the capital expenditure required. AI is not cheap. It demands data centres, specialised chips, vast amounts of energy. The companies best placed to provide these are spending billions. But where is the return? The promised 'productivity revolution' has yet to materialise in the economic data. UK GDP figures remain stubbornly sluggish. Corporate profit margins ex-tech are under pressure. This looks less like a transformative boom and more like a classic case of over-investment.
And what of the central banks? The Bank of England, the Federal Reserve, the ECB – they are all watching inflation with a hawkish eye. If AI enthusiasm keeps asset prices elevated, it may prevent interest rates from falling as quickly as markets hope. Higher for longer is a death sentence for high-growth, high-expectation stocks. The present value of those distant, uncertain AI profits shrinks dramatically when the discount rate rises.
Then there is the issue of concentration risk. Index funds, the darlings of passive investors, are now heavily weighted towards a handful of AI-related stocks. When those stocks turn, the indices will turn with them. The diversification that was supposed to protect savers is an illusion. The entire market has become a bet on the same narrative.
What could trigger the bursting? The most likely catalyst is a simple disappointment. An earnings miss from a key player, a regulatory clampdown on AI data usage, a sudden shift in investor sentiment towards more traditional, value-oriented sectors. The capital that has fled into AI may just as quickly flee out. We have seen it before with the dot-com bubble, with the property bubble, with every mania that promised to change the world.
For now, the bulls point to the genuine technological advances. AI is real. It will change industries. But the market has priced in a decade of progress in just two years. The correction, when it comes, will be painful. It will weed out the pretenders. But it will not destroy the underlying technology. That, I suspect, will emerge stronger from the wreckage of the hype.
The prudent investor should be wary. Diversify beyond the tech behemoths. Look for value in neglected sectors. And remember that markets, like all things, revert to the mean. The party may not be over, but the music is getting softer.
