Is an 'AI' bubble about to pop?

The Bank of England (BoE) is warning of a potential 'AI bubble' that could be as significant as the dot-com bubble of the late 1990s.

In its latest quarterly update, the BoE's Financial Policy Committee (FPC) has warned that there's an increased risk of a 'sudden correction' in the markets.

"On a number of measures, equity market valuations appear stretched, particularly for technology companies focused on Artificial Intelligence," it said.

"This, when combined with increasing concentration within market indices, leaves equity markets particularly exposed should expectations around the impact of AI become less optimistic."

The BoE noted that there were a number of significant bottlenecks to future AI growth, including uncertainties around power, data, and commodity supply chains. It also warned of 'conceptual breakthroughs' that could mean changes to the AI infrastructure required for the development and utilisation of powerful AI models.

The International Monetary Fund (IMF) has raised similar concerns, with its head, Kristalina Georgieva, this week pointing out: "Today's valuations are heading toward levels we saw during the bullishness about the internet 25 years ago."

But we're not quite in bubble territory yet, the BoE said. While the earnings yield implied by the Cyclically Adjusted Price-to-Earnings (CAPE) was 'comparable to the peak of the dotcom bubble', it said, future predictions were rather lower.

Kate Leaman, chief market analyst at broker AvaTrade, acknowledged that the pace of investment in the AI sector over the last year has been dizzying, with valuations in some cases outpacing actual revenue or commercial maturity.

"That said, the underlying technological progress and the breadth of applications being developed justify part of this optimism. AI is not just another tech trend but a foundational shift that's still in an early growth phase," she said.

"The risk isn't necessarily that the AI sector itself is overvalued, but that expectations in public and private markets may be running ahead of near-term fundamentals."

She said that while corrections or valuation adjustments may be on the cards, they are likely to form part of a natural rebalancing as the market settles down and excitement wanes.

"Overall, some caution is certainly warranted – but this shouldn't be characterised as a 'bubble' in the traditional sense," she said. "The long-term value creation potential of AI remains substantial, even if short-term volatility increases."

AI company valuations have reached extremely high levels, with, for example, OpenAI now valued at $500 billion and Anthropic at $170 – more than three times as much as last year.

Share prices for big tech firms such as Nvidia, Microsoft, Apple, Alphabet, Amazon, and Meta now make up around 30% of the S&P 500's total value – marking the highest level of concentration in 50 years.

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