A Bubble Waiting to Burst?

The tech market’s volatility has become a familiar spectacle. Wall Street analysts have been using terms like “crazy days” and “silly season” to describe the market’s behavior, and some are warning that it may be on the verge of a potentially disastrous outcome: a late-stage AI bubble finally bursting.

Capital Economics’ senior markets economist James Reilly has sounded the alarm about a potential AI-fueled market crash. He used eight categories of market indicators to find that most are sitting at or near levels that have historically preceded major peaks, including a 30% decline in the S&P 500 – one of the seven worst crashes in the past century.

The market’s behavior has made this warning more believable and harder to understand. In July, Microsoft’s market value rose by $450 billion on a single day, while Apple’s fell by $360 billion, Amazon gained $388 billion, and Meta dropped $102 billion. These massive moves have left even seasoned analysts struggling to make sense of them.

Owen Lamont, a behavioral economist and portfolio manager at Acadian Asset Management, attempted to put these numbers into perspective. Microsoft’s one-day gain was equivalent to the assessed property value of 1.04 Houstons, while Apple’s loss matched three-and-a-half Hurricane Sandys. This kind of volatility has been on display for months.

The Fed’s Hawkish Turn

Federal Reserve Chair Kevin Warsh has hinted at his hawkish stance on interest rates in recent speeches. In his Jackson Hole speech on August 28, he laid out a framework that would make him the most hawkish Chairman since Paul Volcker in 1979 – but with significant caveats. Warsh inherited far lower inflation and better-anchored expectations than Volcker.

Warsh’s comments have already had an impact on markets, with the odds of a September rate hike jumping from 35% to nearly 60%. A hotter-than-expected August inflation report pushed those odds above 85%. Heading into this week’s Fed meeting, traders are pricing a quarter-point hike, to a range of 3.75% to 4%, as close to a done deal.

The Unusual Convergence

What makes the Fed’s decision strange is the mismatch between the data and the outcome. Core CPI inflation fell to 2.4% in August – a new post-pandemic low. This would normally suggest that the Fed should revise its inflation projections down and its rate-hike projections up. However, according to UBS, something has never happened before: the Fed’s own committee will simultaneously revise its inflation projections down and its rate-hike projections up.

This unusual convergence of events raises more questions than answers. Will the Fed’s decision ultimately end the tech market boom, or is this just another episode in the ongoing saga of Wall Street’s “silly season”? One thing is certain: investors should be bracing themselves for a potentially volatile few weeks ahead.

The AI bubble has become a ticking time bomb. The question now is whether it will explode, sending shockwaves through the global economy, or somehow magically resolve itself – leaving us all wondering if we’re still in the midst of a “late-stage” market boom.