Key Takeaways
For over a year now, market watchers have been concerned that the rapid ascent of AI stocks and, at times, frantic pace of investment in the space could lead to the bubble bursting.
Joining its voice to the conversation, the European Central Bank (ECB) on Wednesday, Nov. 20, warned that the concentration of investment in a handful of U.S. firms could pose a threat to financial stability.
In its November Financial Stability Review , the ECB said there are signs that investors may be underestimating and underpricing the likelihood of a market shock derailing the current AI boom.
Pointing to the high equity market capitalization of a handful of American Big Tech firms, the bank warned that such concentration “raises concerns about the possibility of an AI-related asset price bubble.”
“In a context of deeply integrated global equity markets,” the report added, this “points to the risk of adverse global spillovers, should earnings expectations for these firms be disappointed.”
While most people agree that AI delivers value for businesses, market trends in the last two years have been based on the assumption of massive AI-driven earnings growth.
Companies like Nvidia have seen their earnings swell in line with their market capitalization.
However, firms like Microsoft and Meta still haven’t demonstrated the long-term profitability of their AI business models. Investors who have boosted their stock prices are essentially counting their chickens before they’ve hatched.
As outlined in the ECB’s report, the problem is not that AI itself is overhyped. Rather, investors place too much emphasis on a handful of U.S. firms.
In such a situation, “there is a greater likelihood that negative surprises,” including deteriorating economic growth prospects, changes in monetary policy, or the escalation of geopolitical conflicts, “could trigger abrupt shifts in investor sentiment,” the central bank noted.
Goldman Sachs Strategist Peter Oppenheimer recently put forward a similar view .
Although he argued that AI is not a bubble and is likely to continue to dominate returns, Oppenheimer added the caveat that overconcentration on a handful of tech stocks does pose a risk to investors.
“Concentration risks are high and investors should look to diversify exposure to improve risk-adjusted returns while also gaining access to potential winners in smaller technology companies and other parts of the market, including in the old economy, which will enjoy the growth of more infrastructure spend,” he advised.