Could the AI bubble be about to burst?

If you’ve been around markets for any length of time, the herd mentality at play never fails to raise a chuckle. A case in point: the tech sector losing the contents of its stomach overnight, driven by something any reasonably competent AI could probably have predicted. You couldn’t make it up.

Some facts: the Nasdaq Composite lost 3.6 per cent of its value and the more broadly based S&P 500 fell 2.3 per cent, the worst declines they have posted since 2022.

Even the Dow – which is not a proper stock market index but still gets quoted all over the place – couldn’t avoid getting sucked in, shedding 1.3 per cent.

If those numbers don’t look all that exciting, consider that in actual dollar terms, what went on last night (if you’re of the European persuasion) represents a $1 trillion (£780bn) shellacking. That’s an awful lot of value getting vaporised.

The herd had piled into tech, hugely overexcited by all the AI hype and the gaudy promises made by its leading exponents. The herd is now running because they haven’t (yet) delivered on those. Nor does it look like that will happen any time soon.

Tesla, in particular, has faced the brunt of it. That was largely thanks to a far-from-stellar set of results: Elon Musk’s chatter about bringing lifelike robots to the production line failed to move the market, which was far more interested in the discounting of electronic cars.

However, the other members of the so-called “magnificent seven” of super-performing techs – Microsoft, Amazon, Alphabet (Google to you and me), Meta (Facebook), Apple and Nvidia – also lost ground.

Alphabet’s results were quite different from those of Tesla. It reported better-than-expected earnings and revenues, with search ads and the cloud being the big drivers. But Wall Street was in the mood to find fault, notably baulking at the vast amount of money the company is spending on AI. Nvidia, which is also big in AI, was another big loser as the rout gathered pace.

But is this really a bubble popping? Well, no. Not yet.

For all that the falls were substantial, this is more of a correction than a full-blown crash. A necessary one, at that. They happen, from time to time. Thanks to the herd mentality I spoke of, markets are apt to get ahead of themselves, especially when tech stocks are involved – particularly given the corps buying into the AI hype. That is not to say that a payoff won’t come. But it will take a lot longer than Wall Street is happy to accept.

While the Nasdaq’s single-day decline was spectacular – the magnificent seven had one of the worst days in their illustrious history – it’s early days. When the original dot com bubble of the late 1990s finished popping, the composite had shed fully 78 per cent of its value. This isn’t even close.

Nor do I expect us to see anything quite like that. The seven tech superstars – and the smaller Silicon Valley planets orbiting them – mostly make money in a way that the old dot coms did not. They are run by smart people and staffed by smart people. They’re leaders in their respective fields. This will create a floor under their shares.

Louis Navellier, chief investment officer of Navellier & Associates, wrote in a note that “the flight to quality of Mega Tech is becoming vulnerable to earnings that cannot have even minor disappointments”. There may be more of that next week when Apple, Amazon and Meta report their latest numbers. The pressure is on them to deliver something spectacular if they want to avoid a fresh kicking. However, he added, “The AI narrative isn’t broken.”

No, it isn’t, not yet. But some of the shine has come off it – and profit-hungry investors are starting to look elsewhere for their thrills. This includes some previously unloved sectors, smaller companies among them. Once again, that is necessary – and healthy.