The great artificial intelligence gold rush may be running out of steam. A growing chorus of London's top fund managers is now warning that the AI sector is dangerously overvalued, with some calling for an imminent correction that could wipe billions off the books. The FTSE 100 has already felt the chill, with tech-heavy indices sliding as investors take profits and the smarter money moves to the exits.
For weeks, the chatter in the Square Mile has been about little else. The AI trade has been a one-way bet, driving valuations into the stratosphere on promises of a productivity revolution. But as the Bank of England keeps rates higher for longer, the cost of capital is starting to bite. The era of free money is over, and the punters are now asking hard questions about earnings.
“We are seeing classic signs of a bubble,” said one seasoned hedge fund manager over coffee in Mayfair. “Everyone is piling in because everyone else is piling in. But the fundamentals don't support these multiples. When the music stops, there will be blood.”
His sentiment echoes warnings from bond markets. The yield on the 10-year gilt has crept higher, reflecting a repricing of risk across the board. Higher yields mean higher discount rates, and that is poison for long-duration assets like tech stocks. The maths is simple: if the risk-free rate goes up, the present value of future earnings goes down. And AI companies are all about future earnings.
Capital flight is already underway. We have seen a rotation out of growth stocks and into value, out of tech and into energy and materials. The FTSE 250, which has less tech exposure, has actually outperformed the large-cap index in recent weeks. That is a clear signal: investors are seeking safe harbour.
Then there is the regulatory angle. The government, ever eager to be seen as doing something, is mulling tighter rules on AI. The Prime Minister has called for a “global framework” on AI safety. For the market, that translates to compliance costs and slower adoption. The more the state intervenes, the less attractive the sector becomes.
But the real issue is earnings. For all the hype, many AI companies are still burning cash. The so-called “platform” companies with dominant market positions might survive, but the also-rans will be crushed. We have seen this movie before: the dot-com bubble, the crypto craze. Each time, the narrative is different, but the financial dynamics are identical: excessive leverage, unrealistic expectations, and a sudden realisation that trees do not grow to the sky.
So what comes next? A correction is healthy, of course. It shakes out the weak hands and leaves the market stronger. But the timing is uncertain. The Bank of England is between a rock and a hard place: inflation is sticky, but a rate cut now would only stoke the speculative fire. My bet is that Threadneedle Street holds its nerve, and that will be the catalyst for a sharper sell-off.
The bottom line? The AI bubble is not yet burst, but the air is hissing out. Investors should brace for volatility. The prudent course is to take profits, pare back exposure, and wait for the dust to settle. In this market, cash is not trash: it is a strategic reserve. The time for buying will come, but it is not yet.
