Is the AI stock bubble finally bursting?

This is getting faintly ridiculous now. Yet again, tech stocks are being hit hard — the third shakeout in just the past few weeks. But this is more worrisome than previous outbreaks of nerves. Once more, but this time with feeling, investors are asking: “Is this the big one? Is the AI bubble finally bursting?”

I don’t claim to know the answer. Ask me again in a week or so, and we will know if this wobble deepens and broadens or if it is yet another head fake. But the fact that we’re all asking the same question yet again is very telling in itself.

It is clear that AI technology works. No argument there. But the internet worked out pretty well, and it still crashed the markets a quarter of a century ago. (Sorry if that makes you feel old.)

Any reasonable person can see the hallmarks of an unsustainable party in AI assets, perhaps most conspicuously in AI-related stocks, which truly dominate US and global markets. Pick from a list of possible sources of stress, including high levels of increasingly creatively structured debt, questionable levels of true revenue potential, and head-scratching examples of circular financing.

As the Bank for International Settlements recently pointed out, nearly 29 per cent of AI firms’ investment deals are in other AI firms, and more than half of incoming investment in AI firms comes from other AI firms. In a crisis, circular financing can easily turn into a circular firing squad.

All of this has been true and widely accepted to be the potential nexus of a correction for months. We have just never really known what would be the trigger.

US politics may finally be that thing. The initial reaction to this week’s historic US midterm elections, which delivered thumping victories for the Democratic Party across Congress and in state-level positions, was very positive. Stocks sailed higher all around the world, partly in relief that the result was unambiguous and uncontested, partly in hope that we could make markets normal again with stronger checks and balances to a capricious president, and partly on the sense that the elections could bring forward the end to the apparently senseless war in Iran.

The price of oil tumbled under $100 a barrel, having stood as high as $118 at the end of last month, after voters across the US sent a strong message that they were fed up with war-driven high energy prices jacking up the cost of living (and of driving). The market’s judgment is that one way or another, the war has to end, and fast.

But the good vibes in markets lasted all of a day. That is because the other thing voters made clear was that they do not like AI, and specifically that they do not want enormous energy- and water-guzzling data centres built in their neighbourhoods. AI itself was on the ballot across multiple states, with measures seeking views from voters on whether to delay or restrict data centre developments. Voters stuck up two fingers at Big Tech almost every time. A much tougher regulatory and permitting framework lies ahead for a sector holding up an alarming amount of sky in the US economy and in global markets.

Frank Flight, a strategist at Citadel Securities, said in a note on Thursday that in theory, at least some of these projects will simply shift from unfriendly to friendly states. They still end up happening.

Maybe. But this is still a problem for projects financed with huge amounts of borrowed money. “Securing alternative sites, power and approvals takes time, so this adjustment could still materially delay deployment and raise costs,” he said. “We would therefore expect some moderation in the near-term growth and inflation impulse from construction and associated resource demand, alongside a smaller impact on cumulative investment and financing requirements.”

Diversified technology companies, particularly those with data centre capacity already tied up, are faring relatively well in the latest burst of stress, which on Thursday dragged the techy Nasdaq Composite 5 per cent, its biggest fall in 19 months. But pure-play AI build-out bets have taken a real beating. CoreWeave stocks fell 10 per cent on Thursday alone, taking their decline since the peak in May to 70 per cent. Chips maker Sandisk fell 22 per cent on Thursday. Micron dropped 17 per cent.

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“At these valuations, the AI trade is like a shark that has to keep swimming to stay alive,” said Trevor Greetham, head of multi-asset at Royal London Asset Management.

Before the midterms, in October, Dario Perkins at research house TS Lombard sketched out what a true crash in the AI trade might look like. Naturally, a lot of this is guesswork, but he reckons a worst-case scenario could wipe at least 30 per cent off US stocks and spark up to $200bn in credit losses, with “a wave” of tech-related debt defaults.

For stocks, “these are conservative estimates, which take the tech share of the US market back to pre-ChatGPT days”, he said. Government bonds and non-US stocks stand out as potential refuges, he added. It is a sobering analysis, but plausible too — tellingly, US Treasury bonds have already turned higher.

A swift end to the war in Iran still stands as the best chance for markets to regain a solid footing. But one day, the alarm from the AI trade will not be a drill.

katie.martin@ft.com