ECB sounds warning over prospect of 'bubble' in AI stocks

Investing.com -- Risks of a potential AI-related asset price bubble in equity markets remain despite recent corrections, the European Central Bank (ECB) warned in a recent report.

In its latest Financial Stability Review, the ECB highlighted the increasing concentration of equity market capitalization and earnings among a small group of technology firms, primarily in the United States, many of which are at the forefront of the ongoing AI boom.

The ECB noted that this concentration, often referred to as the dominance of the "Magnificent 7" — companies such as Alphabet (NASDAQ:GOOGL ), Apple (NASDAQ:AAPL ), and Microsoft (NASDAQ:MSFT ) — has created vulnerabilities in global equity markets.

“This concentration among a few large firms raises concerns over the possibility of an AI-related asset price bubble,” the report notes.

Global interconnectedness adds another layer of risk. The ECB emphasized that "in a context of deeply integrated global equity markets," any disappointment in the earnings of these firms could trigger adverse spillovers across asset classes and geographies.

The rise of AI has led to soaring valuations, but the ECB cautioned that the market could be vulnerable to unexpected changes in sentiment.

“There is a greater likelihood that negative surprises – including sharply deteriorating economic growth prospects, sudden changes in monetary policy expectations or further escalation of ongoing geopolitical conflicts – could trigger abrupt shifts in investor sentiment, resulting in spillovers across asset classes,” the report says.

With liquidity in equity markets remaining heavily concentrated within a small group of companies, risks of stock dispersion are greater, the ECB explains.

This combination of elevated valuations and extreme reliance on a few dominant stocks raises the risk of individual shocks cascading into systemic events. Market sensitivity to these companies now rivals that of major macroeconomic developments.

"Valuations and risk premia are therefore vulnerable to a shift in risk appetite," the ECB warns.

Sudden spikes in market volatility could further lead to forced asset sales by euro area investment funds, amplifying stress in corporate bond markets. That risk is exacerbated by the sizable role these funds play in the euro area bond market.

For non-bank entities, the growing concentration of equity investments in US technology stocks significantly increases exposure to potential "revaluation shocks,” the ECB adds.

Source: Investing.com