The AI valuation bubble is now getting silly (Nils Pratley/Guardian)
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First, valuations are extremely stretched by usual standards. Everybody – including the Bank of England’s financial policy committee in its report on Wednesday – is staring at market historians’ favourite yardstick, the Cape ratio, with amazement or alarm. The Cape measures cyclically adjusted price-to-earnings ratios over the past decade taking account of inflation. On that score, we’re back at the peak dotcom bubble. The better news is that, on a plainer, forward-looking, price-to-earnings ratio, the S&P 500 index is at 25 times, which is not as severe as 1999 levels. But the overall picture is clear: prices are very high.
Second, concentration risk in markets is off the charts. The “Magnificent 7” tech companies – Alphabet, Amazon, Meta, Tesla, Apple, Microsoft and Nvidia – now represent slightly more than a third of the whole S&P 500 index. To varying degrees, all are bets on the future of AI. If, or when, the AI bubble bursts, there will be few places to escape the pop. One doubts the concentration is appreciated by US holders of tracker funds who look to invest in a diversified portfolio of companies. And, given the dominance of the US in global indices, the same applies to a lesser degree for your everyday global tracker, too.
Third, the correlation risk is becoming worse given the AI firms’ obsession with cross-shareholdings and partnerships. The deal whereby OpenAI will pay Nvidia for chips, and Nvidia will invest $100bn in OpenAI, has been criticised as circular because that’s exactly what it is. In the latest move, OpenAI has pledged to buy lots of AMD chips and take a stake in AMD over time. Fans of these arrangements see an alignment of interests for mutual gain. One can equally view the fancy financial footwork as a formula for ensuring capital is misallocated. Certainly, the strain of getting the AI infrastructure built – before returns are remotely clear – seems to be showing.
Fourth, the wider economic backdrop for an IT revolution is not as helpful as in the 1990s. “Inflation wasn’t a problem in the 90s,” argued Dario Perkins of TS Lombard recently. “Outside the IT sector, there were powerful structural forces keeping prices down, such as rapid globalisation and the collapse of the Soviet Union.” As he says, that’s not today’s world of deglobalisation, supply shocks, anxiety about public finances and lurches towards populism. Conditions are less favourable for a sustained “melt-up”, he concludes. That sounds right.
***https://www.theguardian.com/technology/nils-pratley-on-finance/2025/oct/08/the-ai-valuation-bubble-is-now-getting-silly
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