The AI bubble warning was sounded before the worst market plunge since Black Monday

Tuesday, 6 August 2024

Warnings of the AI bubble bursting had been sounded before a plunge on global markets reminiscent of 1987 's crash swept around the world.

Monday’s drops were the latest in a global sell-off that began last week, and were accelerated by US job data on Friday that sparked fears of a slowing US economy.

Japan’s Nikkei 225 plunged 12.4% for its worst day since the Black Monday crash of 1987.

The plunge was the first chance for traders in Tokyo to react to Friday’s report showing US employers slowed their hiring last month by much more than economists expected.

That was the latest piece of data on the US economy to come in weaker than expected, and it’s all raised fear the Federal Reserve has pressed the brakes on the US economy by too much for too long through high interest rates in hopes of stifling inflation.

Bursting of the bubble?

Last month, The Washington Post reported that Wall Street analysts and tech investors were sounding the alarm that the immense amount of money being poured into artificial intelligence could be leading to a financial bubble.

“Despite its expensive price tag, the technology is nowhere near where it needs to be in order to be useful,” Jim Covello, Goldman Sachs’s most senior stock analyst and a 30-year veteran of covering tech companies, said. “Overbuilding things the world doesn’t have use for, or is not ready for, typically ends badly.”

Covello’s comments are in sharp contrast to a different Goldman Sachs report from just over a year ago, in which some of the bank’s economists said AI could automate 300 million jobs around the world and increase global economic output by 7 percent in the next 10 years, spurring a spate of news coverage about the disruptive potential of AI.

Influential investor Cathie Wood, a bullish supporter of Silicon Valley, said the rush to own the six largest US tech stocks had left the market at its most concentrated “since the Great Depression in the 1930s”, The Telegraph reports.

She said the six largest US tech stocks – Nvidia, Apple, Microsoft, Amazon, Microsoft and Meta – were “taking up so much oxygen from the investment room” that the market “knows that the increased concentration is developing into a risk”.

“History books will be written about this,” she said.

“Investors are concerned about this concentration and the risk that the concentration is introducing into their own system.”

Comparisons are being drawn with the dot com bubble of 25 years ago and even, more worryingly, with the railway mania of the 1840s, with which the ongoing AI mania has some similarities, The Telegraph reports.

Chance of the US going into recession

Goldman Sachs economist David Mericle sees a higher chance of a recession within the next 12 months following Friday’s jobs report. But he still sees only a 25% probability of that, up from 15%, in part “because the data look fine overall” and he does not “see major financial imbalances.”

Some of Wall Street's recent declines may simply be air coming out of a stock market that romped to dozens of all-time highs this year, in part on a frenzy around artificial-intelligence technology. Critics have been saying for a while that the stock market looked expensive after prices rose faster than corporate profits.

“Markets tend to move higher like they’re climbing stairs, and they go down like they’re falling out a window,” according to JJ Kinahan, CEO of IG North America. He chalks much of the recent worries to euphoria around AI subsiding, with pressure rising on companies to show how AI is turning into profits, and “a market that was ahead of itself.”

Professional investors also pointed to the Bank of Japan's move last week to raise its main interest rate from nearly zero. Such a move helps boost the value of the Japanese yen, but it could also force traders to scramble out of deals where they borrowed money for virtually no cost in Japan and invested it elsewhere around the world.

Sharp losses on tech stocks

Stocks of companies whose profits are most closely tied to the economy’s strength took sharp losses on the fears about a slowdown. The small companies in the Russell 2000 index dropped 3.7%, further dousing what had been a revival for it and other beaten-down areas of the market.

Making things worse for Wall Street, Big Tech stocks also tumbled as the market’s most popular trade for much of this year continued to unravel. Apple, Nvidia and a handful of other Big Tech stocks known as the “ Magnificent Seven

Apple fell 6.5% on Monday after Warren Buffett’s Berkshire Hathaway disclosed that it had slashed its ownership stake in the iPhone maker.

Nvidia, the chip company that’s become the poster child of Wall Street’s AI bonanza, fell even more, 7.2%. Analysts cut their profit forecasts over the weekend for the company after a report from The Information said Nvidia’s new AI chip is delayed. The recent selling has trimmed Nvidia's gain for the year to 101.1% from 170% in the middle of June.

War and elections add to uncertainty

Worries outside corporate profits, interest rates and the economy are also weighing on the market. The Israel-Hamas war may be worsening, which beyond its human toll could also cause sharp swings for the price of oil. That’s adding to broader worries about potential hotspots around the world, while upcoming S. elections could further scramble things.

Wall Street has been concerned about how policies coming out of November could impact markets, but the sharp swings for stock prices could affect the election itself.

The threat of a recession is likely to put Vice President Kamala Harris on the defensive. But slower growth could also further reduce inflation and force former President Donald Trump to pivot from his current focus on higher prices to outlining ways to revive the economy.

“It comes down to jobs,” said Quincy Krosby, chief global strategist for LPL Financial. They drive spending by U.S. consumers, which in turn is the biggest part of the US economy.

“When we get to election day, the unemployment rate is going to be extremely important.”

– Stuff and AP