AI - Is this a bubble?
There have been a lot of press articles about bubbles relating to Artificial Intelligence (AI) and the recent strong markets, so we thought it best to share our views on the matter.
A stock market bubble begins when a new technology or opportunity attracts investors, causing prices to rise. As more people notice the gains, public enthusiasm grows and pushes prices upward even faster. Eventually, excitement turns into mania, where investors ignore risks and buy simply because prices keep climbing. When the market reaches euphoria, stock prices are far above their real value and extremely fragile. Any shift in confidence can trigger panic selling, leading to a rapid price collapse and the bursting of the bubble (courtesy of ChatGPT).
Some bubbles are grounded in truly transformative technology. These have been described by Amazon founder Jeff Bezos as an “Industrial Bubble”. Examples of Industrial Bubbles include the Railway Mania of the 1840s1, the US Railroad Mania of the 1870s2, radio and automobiles in the Roaring Twenties3 and of course the Dot Com (also called the Telecom, Media and Technology …TMT) bubble of 20004. On the other hand, there are purely speculative bubbles of which Tulip Mania of the 17th century remains the poster child5. Clients who are interested in this topic should read “Extraordinary Popular Delusions and the Madness of Crowds” by Charles Mackay. Although it was first published in 1841 it is still relevant as manias and bubbles are a result of human behaviour and therefore share common factors.
Are we in an AI bubble? The amount of money being spent by some of the large technology companies (hyperscalers) on chips and data processing centres is mind-boggling. One estimate puts this at USD 350bn (equivalent to the GDP of the Czech Republic) this year and Goldman Sachs estimates that the total expenditure could amount to USD 4tn by 2030. The adoption of AI has been rapid and still has a long way to go, and there is no doubt that it is a transformative technology. The hyperscalers are already generating revenue (though not profits on their AI investments) but there is no doubt that not all this spending will earn a proper return on the capital invested, there will be losers who will have to write off a significant portion of their investment. So, are we in an AI bubble? Certainly, Jeff Bezos thinks AI is in an Industrial Bubble.
Are we in a speculative or stock market bubble? As we have often written, market valuations, especially US equities are expensive. But they remain, on many measures materially below the levels reached at the peak of the TMT bubble in early 2000. Unlike 2000 where few companies were profitable, many of the hyperscalers are very profitable businesses with near monopolies in their subsectors. Importantly, valuations have been supported by earnings growth. For instance, the US grew an estimated 13.1% year-on-year in 3Q25, marking the fourth consecutive quarter of double-digit growth. The technology sector is expected to have reported 3Q25 earnings growth of 27.1%, measurably above the 20.9% growth rate that analysts had forecast at the start of reporting season. Among the AI hyperscalers the three largest cloud computing platforms, Amazon, Google, and Microsoft, collectively reported growth of 28.5% year-on-year.
There is no doubt that the share prices of the hyperscalers have risen considerably and that they have grown to account for over 35% of the S&P 5006. This certainly raises questions about the level of diversification in index tracking funds. In fact, a very large proportion of this year’s market performance can be attributed to AI and AI related stocks including those companies in building the data centres such as Caterpillar.
Another element to consider is borrowing, also known as leverage. It is leverage that provides the “air” that inflates a bubble to the point where it becomes unsustainable. As far as knowledgeable observers can tell, leverage is increasing in many parts of the market but does not appear to be at levels that the levels seen in prior market peaks.
One other factor to consider, investor euphoria or Irrational Exuberance7. It is often said that bull markets climb a wall of worry and yet survey data of both retail and institutional investors shows little sign of irrational exuberance. On the other hand, there is little doubt that US consumer sentiment is being positively influenced by stock and housing market gains.
Of the four classic elements of a financial bubble, rapidly rising asset prices, extreme valuations, euphoria and rising risk driven by increased leverage only one (rapidly rising prices) is flashing red. The rest are at amber. So, are we in a stock market bubble? Possibly but our assessment is that we are not yet in a fully fledged speculative bubble.
The Cavendish Ware portfolios are conservatively positioned. We are underweight equities, underweight US equities and by selecting funds whose managers have a strong valuation discipline, we are significantly underweight large tech companies.
In this note we have focused on the US because it will set the direction for all equity markets. If we are wrong and we are in a stock market bubble that bursts, then we believe our positioning should help protect on the downside but will not insulate the portfolios entirely.
Bubbles are difficult to spot because market valuations often become dislocated from fundamental values and are frequently accompanied by strong narratives. A crash or bear market (a prolonged period of negative returns with declines greater than 30%) isn’t always inevitable. As always, we will repeat the old adage that time in the market, not market timing, is the key to long term returns. But if you have a short time horizon or your appetite for risk has reduced then please do speak to your adviser.
2 Panic of 1873 - Wikipedia; How One Robber Baron's Gamble on Railroads Brought Down His Bank and Plunged the U.S. Into the First Great Depression
3 Roaring Twenties - Wikipedia
6 The S&P500 is the main benchmark of the US equity market comprising the top 500 companies by market capitalisation.
7 Irrational exuberance - Wikipedia
Past performance is not a guide to future performance. The value of an investment and the income from it may fall as well as rise and the amount of money you get back could be less than the amount invested.
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