- US and European stocks hit records amid AI-driven market rally, ECB warns correction likely
- ECB economists cite past tech revolutions showing corrections follow stock market booms
- Overoptimistic investors often drive prices above fundamentals, leading to eventual crashes
As US and European stocks hit fresh records as positive sentiment over artificial intelligence continues to fuel market rally, ECB economists warn that the boom could be setting the stage for a sharp correction.
“Economic research on past technological revolutions points to a worrisome conclusion: a correction of current stock market valuations is likely,” the economists wrote in a blog Monday, reffering to two possible scenarios.
According to economists, a correction is expected as “overconfident, overoptimistic investors” typically drive stock prices higher, more than its fundamental value, resulting in a crash when that frenzy fades.
A drop in prices, however is likely even if the present current valuations are a correct indication of AI's ability to redefine the global economy and push corporate profits up.
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What Does History Suggest?
ECB economists compared AI boom to technological advancements in the past that were expected to reshape global economy. They referred to examples such as 19th century's railway boom, the expansion of electricity and radio in the 1920s, and growth of internet in the 1990s and the dotcom bubble of the early 2000s.
In every case, investors remained concerned over whether the technology-led shift will boost the broader economy or not.
“As adoption spreads...uncertainty becomes economy-wide. If something then goes wrong with that technology, the whole economy suffers,” the economists said.
This uncertainty will require a higher risk premium, which is likely to push stock prices down over time, even if growth in profit remains strong, the analysis by ECB economists states.
“Both views imply a boom followed by a correction, or a pullback from wherever valuations have risen, at some point in the future,” they said, adding that it could be followed by a recovery and more jump in stocks.
Urging investors to be prepared for the crash, they said, “The exact timing is unknowable in advance. These boom-bust patterns are only identifiable with hindsight."
They added, "unlike in the dot-com episode, today's starting point leaves markedly less room to cut interest rates or use fiscal policy to cushion the fallout."
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