Amidst the surging excitement around artificial intelligence, market chatter has increasingly turned to the dreaded 'b' word: bubble. Google searches linking AI with bubbles have skyrocketed, and a palpable sense of exuberance fills the financial air. Yet, beyond these anecdotal indicators, there remains no universally accepted gauge for a true market mania. Renowned investor and author Ruchir Sharma offers a concrete framework to cut through the noise: his test of four critical 'O's—overvaluation, over-ownership, over-investment, and over-leverage. Here is how the current AI wave measures up against this rigorous checklist.
Overvaluation: Prices Flashing Red
Sharma's analysis draws on historical precedent, examining major bubbles from gold in the 1970s to the dot-com boom of the late 1990s. A common thread he identifies is a ten-fold increase in inflation-adjusted prices over a 10 to 15-year period. Notably, U.S. technology shares have recently reached this very threshold. Further historical study reveals that when the core industry of a mania outperforms the broader market by more than 100 percent over two years, the probability of a subsequent crash exceeds 50 percent. AI-related stocks are now hovering alarmingly close to this tipping point.
These dramatic price surges have propelled the long-term valuations of U.S. equities to near-historic highs. While some proponents argue that AI will deliver growth far surpassing previous technological revolutions and that valuations were more extreme in 1999, Sharma urges caution. If history serves as a guide, both current valuations and price trajectories are emitting a deep-red bubble warning signal that investors would be wise to heed.
Over-Ownership and Overtrading: The Retail Frenzy
The second 'O' scrutinizes the flow of capital into the hot sector. In the United States, the chase for tech stocks has become a national pursuit. Households now hold a record 52 percent of their wealth in equities, a level that surpasses the peak of the 2000 dot-com bubble and dwarfs holdings in the EU (30%), Japan (20%), and the U.K. (15%).
A related and telling signal is overtrading. Over the past five years, the daily volume of shares traded in the U.S. has jumped by 60 percent to approximately 18 billion. There has also been a significant shift in retail investor behavior, with their share of short-dated stock options swelling from one-third to more than half. Sharma points to a concerning trend of 'financial nihilism' among younger generations, who turn to speculation after giving up on traditional goals like home ownership.
This retail impulse is clear: on platforms like Robinhood, the five most heavily owned stocks are all members of the so-called 'Magnificent Seven' tech giants. With an estimated $7.5 trillion still parked in money market funds, small U.S. investors may yet have more buying power to deploy, further fueling the cycle.
The Strange New Animal: The Fully Invested Bear
Despite scepticism in some quarters, persistently loose financial conditions and abundant liquidity continue to push stock prices upward. This dynamic, Sharma observes, is almost forcing institutional investors to keep buying to avoid underperformance, even if they privately doubt the AI euphoria. The result is a paradoxical market creature: the 'fully invested bear'—a professional who is pessimistic but remains fully allocated to the rising market.
Proponents of the AI revolution often counter bubble fears by arguing that true market peaks arrive only when worry vanishes and optimism is universal. They suggest that the current incessant bubble talk itself is proof that a top is not yet in sight. However, Sharma notes that concern was indeed growing in the year leading up to the dot-com crash, with warnings issued by the San Francisco Fed, numerous columnists, economists, and institutional investors. The parallel to today's climate of cautious exuberance, he implies, is striking.
As the debate continues, Sharma's four 'O's provide a structured, fact-based lens through which Canadian and global investors can assess the sustainability of the AI-driven market rally. The data suggests that while the transformative potential of artificial intelligence is undeniable, several traditional markers of a financial bubble are already illuminated, warranting a measured and disciplined investment approach.
