ECONOMIC expansions do not die of old age, and stock market rallies rarely do either. Some catalyst is needed to burst the bubble.
In the case of the current artificial intelligence (AI) boom, that may well be rising interest rates. Economist Rudi Dornbusch famously said that ageing expansions are killing the Federal Reserve (Fed).
Given the US equity market’s sharp pullback last Friday – particularly the move in tech – it looks like investors fear the Fed may strike again, only this time the main victim will be Wall Street.
The Nasdaq fell more than 4% last Friday, its biggest drop since the tariff turmoil on “Liberation Day” in April last year.
Even more strikingly, the SOX chipmaker index plunged 10%, its biggest fall since the pandemic in 2020, and the fourth-largest drop since the index was launched in 1994.
True, the SOX had nearly doubled this year, but Friday’s move was still seismic. Some US$2 trillion was wiped off the value of US equities, more than half of that in chip stocks.
The sell-off was notable not only for its ferocity, but also its trigger: bumper US employment data.
The rise in job growth in May came in at 172,000, double consensus expectations, while hiring in the previous two months was revised up sharply too.
Typically, this would be good news, a reflection of a strong economy and buoyant consumer demand that should, theoretically, boost firms’ profits.
But Wall Street deemed the non-farm payrolls report to be “bad news” because it screamed “higher interest rates”.
Combine that with a market priced for perfection, and you have the recipe for a major reversal. Signs have been multiplying that the AI mania is getting out of hand.
For one, there’s the massive increase in AI capital expenditure (capex) forecasts, which naturally raises questions about future returns on that investment.
Analysts at Goldman Sachs last week said they now expect US$5.3 trillion of capex spending in 2025 to 2030 from the four largest hyperscalers, Meta, Microsoft, Amazon and Alphabet. That’s up from US$4.5 trillion before the first-quarter (1Q) earnings season.
Then there’s the eye-popping initial public offering (IPO) blitz.
The public listings of SpaceX, Anthropic and OpenAI are expected to deliver a combined market cap valuation just under US$4 trillion.
SpaceX’s 2025 sales were less than US$20bil, OpenAI’s annualised revenue barely topped US$20bil and Anthropic’s 1Q take this year was less than US$5bil.
These figures will undoubtedly grow, but enough to justify these eye-watering IPO valuations?
Bubble signs are flashing. Equity strategists at Citi warned that their global “bear market checklist” was at its frothiest level since the global financial crisis in 2008 – and getting frothier.
The checklist comprises 18 “red flags”, including earnings forecasts, fund flows, valuations, capex, investor sentiment, and equity issuance.
The checklist is not yet signalling the “overexuberance” that precipitated 2000 and 2008 bear markets, Citi noted, but the direction of travel is worrying. “Once the count reaches double digits, it has historically tended to rise more rapidly, signalling a potential acceleration in risk.”
Sure, rotation within tech and across sectors picked up in recent months and some large tech companies have registered big short-term share price declines.
But the benchmark indices continued to hit new high after new high.
So why might this pullback be different?
Bubbles tend not to be burst by a single trigger, but by a range of indicators moving into more extreme territory.
Yet, some triggers pack more of a punch than others. The cost of money is one of them. — Reuters
Jamie McGeever is a columnist for Reuters. The views expressed here are the writer’s own.
