The City is aflutter with talk of a bubble. Not the old-fashioned kind of tulips or subprime mortgages, but a mania of a more modern stripe: artificial intelligence. British fintech leaders, a group not typically known for pulling their punches, have begun to sound the alarm. They warn that the current speculative frenzy in AI stocks bears all the hallmarks of a classic bubble, and they fear a painful correction that could leave investors nursing heavy losses.
The numbers, as always, tell a story. The tech-heavy Nasdaq Composite has surged nearly 40% over the past year, with AI-related stocks such as Nvidia and Palantir leading the charge. Nvidia, whose chips power many AI applications, has seen its market capitalisation balloon to over $2 trillion, a figure that would have been laughable just five years ago. Yet the company’s price-to-earnings ratio, a traditional measure of value, now stands at over 70. That is more than double the S&P 500’s average. History suggests such valuations are rarely sustainable.
“We are seeing a level of irrational exuberance that I have not witnessed since the dot-com era,” said Sir Martin Sorrell, the veteran advertising magnate and founder of S4 Capital. “Investors are piling into anything with the letters A and I attached, without any regard for fundamentals. This is a recipe for disaster.”
Sorrell’s view is echoed by a growing chorus of industry insiders. The fintech sector, which was itself caught up in a speculative froth just a few years ago, has learned some hard lessons. Many of the high-flying startups of 2021 have since seen their valuations slashed or have gone bust. The survivors are now urging caution.
“The parallels with the crypto mania are unmistakable,” said Anne Boden, founder of Starling Bank. “Back then, people were throwing money at any project that mentioned blockchain, without asking how it would make money. Now they are doing the same with AI. The hype has completely detached from reality.”
Indeed, the number of AI-related initial public offerings (IPOs) has exploded. In the first quarter of this year alone, 12 AI companies have listed on the London Stock Exchange, raising a total of £1.5 billion. Many of these companies have yet to turn a profit. Some have no revenue at all. Yet they are being valued at multiples that would make a tech unicorn blush.
Take Oxford Dynamics, a startup that claims to use AI to optimise energy efficiency in commercial buildings. On the day of its IPO, its shares soared 150%, giving it a market cap of £800 million. The company’s annual revenue? A mere £2 million. Its CEO, Dr. James Hollingsworth, defended the valuation, citing the “transformative potential” of the technology. But sceptics are not buying it.
“This is not investing; it is gambling,” said John Repton, a fund manager at Newton Investment Management. “We are seeing a massive misallocation of capital, driven by fear of missing out. When the music stops, a lot of people will be left without a chair.”
The Bank of England, too, is watching closely. Governor Andrew Bailey has expressed concerns about the “irrationality” in some asset prices, although he has stopped short of calling it a bubble. The Financial Conduct Authority has also issued a warning, urging investors to “exercise caution” in the AI space. But whether these admonitions will be heeded is another matter.
The root cause of this frenzy is not hard to identify. The era of ultra-low interest rates has left investors starved for yield, prompting them to chase ever more risky assets. And what could be more seductive than the promise of a technology that is supposed to revolutionise everything, from healthcare to finance?
Yet the parallels with the dot-com bubble are uncanny. Back then, companies that added a “.com” to their name saw their stocks skyrocket, regardless of their business models. The bubble burst in 2000, wiping out $5 trillion in market value. The AI bubble, if it comes to pass, could be just as devastating.
What is particularly alarming is the role of retail investors, who have become increasingly active in the stock market thanks to zero-commission trading apps. Many of these investors, hooked on the adrenaline rush of quick gains, are piling into AI stocks with little understanding of the underlying technology or its limitations.
“It is a classic case of speculation masquerading as investment,” said Repton. “The sad thing is that when the crash comes, it will be the small investors who get burned the most. The insiders will have already cashed out.”
So what should a prudent investor do? The answer, as always, is to focus on fundamentals. AI is indeed a transformative technology, but not all AI companies are created equal. Those with strong intellectual property, clear revenue models, and sustainable competitive advantages are likely to survive and thrive. The rest will be forgotten.
In the meantime, the Bank of England would do well to keep a close eye on this exuberance. A correction in AI stocks could spill over into the broader economy, especially if it triggers a wave of defaults or a tightening of credit conditions. But for now, the bubble continues to inflate. And the City, as ever, remains caught between greed and fear.
