European Central Bank economists warn that a correction in AI-driven stock valuations is likely, even if current prices accurately capture the technology's potential to reshape the economy. They point to parallels with the railway, electricity, and internet booms, and flag that European retail investors are heavily exposed through Magnificent 7-dominated index funds.
ECB economists flag a coming correction
Economists at the European Central Bank wrote in a Monday blog post that "a correction of current stock market valuations is likely," pointing to research on past technological revolutions. The warning comes as U.S. and European stocks push to record highs on the back of the AI boom.
The economists lay out two scenarios that both end the same way. A correction could hit if overconfident, overoptimistic investors push prices beyond their fundamental worth, leading to a crash once that exuberance fades. But even if today's valuations correctly reflect AI's power to lift corporate profits, a pullback should still be expected as risk premia rise.
History rhymes: railways, electricity, and the internet
To make their case, the economists cite the 19th-century railway boom, the 1920s expansion of electricity and radio, and the rise of the internet in the 1990s. In each episode, uncertainty about a transformative technology spread through the wider economy as adoption widened, and investors eventually demanded a higher risk premium that is likely to eventually drive stock prices down, even if profit growth remains robust.
According to CNBC: "The exact timing is unknowable in advance." The ECB economists said boom-bust patterns like these are only identifiable with hindsight, noting that any pullback could be followed by a recovery and a further climb in stocks.
European investors exposed through index funds
The blog also warns of the fallout from such a pullback. European retail investors are highly exposed, potentially without knowing it, through the prevalence of Magnificent 7 stocks in global index funds and pension funds, the economists said. They add that a sharp correction could trigger knock-on effects through fund-based structures that eventually threaten euro area stability.
Unlike the dot-com era, the economists note, today's starting point leaves markedly less room to cut interest rates or use fiscal policy to cushion the fallout.
Source: CNBC
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