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The artificial intelligence boom could turn into “absolute insanity” if a stock market bubble forms, according to TS Lombard.
The investment firm outlined the three key ingredients needed to create a stock market bubble.
“The AI frenzy… in the past few weeks has the hallmarks of a potential bubble. But we are not in one right now,” TS Lombard said.
Artificial intelligence has emerged on Wall Street as the new theme that is driving stock market prices higher, and it could turn into “absolute insanity” if a bubble eventually forms, according to a note this week from TS Lombard.
The firm said that there are three key ingredients needed to form a stock market bubble, but one of them is currently missing, leading them to conclude that stocks are not yet in a bubble… yet.
Those three ingredients are:
“A solid fundamental story.”
“A compelling narrative for future growth.”
“Liquidity, leverage, or both.”
“The hype around AI risks creating the second tech bubble in just three years. However, there are no signs of ‘absolute insanity’ in stocks, at least for now,” TS Lombard’s Andrew Cicione said.
While the hype surrounding AI and its growth potential meet the first two criteria of the stock market bubble checklist, the last ingredient of liquidity and leverage appear to be missing. Investors can thank the Federal Reserve’s ongoing balance sheet reduction plan for that.
“Unlike in 2020, central banks are shrinking their balance sheet. Narrow money is shrinking in most major economies, and broad money is decelerating fast,” Cicione said.
Meanwhile, investor leverage has cratered over the past year as the stock market suffered a painful bear market throughout 2022, with absolute FINRA margin debt seeing a bigger decline today than during the 2008 Great Financial Crisis.
Another factor that’s limiting the formation of a bubble is that fewer people are sitting at home speculating on the stock market today than they were during the COVID-19 pandemic in 2020 and 2021.
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