The surge in artificial intelligence-related shares has pushed US stock market valuations close to historic highs, leading economists writing on the European Central Bank’s blog to conclude that a future correction is likely.
Their analysis warns that the effects could spread to the euro area through investors’ exposure to major US technology companies and the close relationship between American and European equity markets. However, the authors stress that the timing of any correction cannot be predicted.
Technology booms have followed a similar pattern
The economists compare the current enthusiasm surrounding AI with earlier technological revolutions, including railways, electricity, radio and the internet.
Each represented a genuine transformation of the economy and attracted substantial investment. However, the valuations of companies leading those developments rose sharply before eventually falling.
The authors argue that a future correction would not necessarily mean AI had failed or that current investor interest was entirely irrational. Share prices could decline even if the technology delivers higher productivity and corporate profits.
Why prices could fall even if AI succeeds
Investors initially place high values on companies adopting a new technology because of their potentially large, but uncertain, future gains.
As the technology spreads throughout the economy, however, the associated risks become broader and more difficult to diversify. Investors may then demand higher returns to compensate for that risk, placing downward pressure on share prices.
A second explanation involves investor behaviour. Excessive optimism can push valuations beyond the level justified by company earnings, potentially resulting in a steeper fall when expectations change.
The authors emphasise that valuations could still rise further before any correction. The precise timing and scale of a downturn remain unknowable in advance.
Euro area households have €440 billion exposure
Euro area households hold approximately €440 billion in US technology shares, largely through mutual funds and exchange-traded funds rather than direct investments.
Much of that exposure is concentrated in the so-called Magnificent Seven: Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla. Insurance companies and pension funds also hold significant stakes in the same companies.
The structure of these investments could amplify a market decline. If investors withdraw money from funds during a sharp correction, fund managers may be forced to sell assets, placing additional pressure on prices and potentially prompting further withdrawals.
According to the economists, this transforms a possible decline in US technology shares from a private investment risk into a broader financial stability concern for the euro area.
European markets remain closely connected
Euro area stock valuations are lower than those in the United States, while European markets are less heavily dominated by technology companies. This reduces the likelihood of a home-grown correction of the same scale.
Nevertheless, European and US equity markets have historically moved closely together. A major fall on Wall Street could therefore affect European share prices, investor confidence, financing conditions and hiring.
The authors also warn that policymakers have less room to respond than during the dot-com collapse, with more limited scope to cut interest rates or use public spending to cushion a wider downturn.
The analysis reflects the views of its five authors and does not necessarily represent the official position of the European Central Bank or the Eurosystem.
Sources: ECB Blog, Reuters.
