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Surging valuations of artificial intelligence companies are intensifying the risk of a “sudden correction” in global financial markets after equity prices reached levels comparable with the dotcom bubble, the Bank of England has warned.
“The risk of a sharp market correction has increased,” said the BoE’s Financial Policy Committee, which oversees financial stability risks, in the record of its latest meeting on Wednesday.
The dangers of a market reversal have been compounded by defaults in US automotive credit markets in recent months, the BoE said, adding that these “underscore some of the risks” it has been highlighting in market-based finance.
Additional risks stem from rising political pressure on the US Federal Reserve, which “could result in a sharp re-pricing of US dollar assets” and from uncertainty around “political deadlocks in France and Japan”, which also threaten to disrupt debt markets.
The BoE said that on a number of measures “equity market valuations appear stretched, particularly for technology companies focused on artificial intelligence”.
“This, when combined with increasing concentration within market indices, leaves equity markets particularly exposed should expectations around the impact of AI become less optimistic.”
It is the clearest warning to date by the BoE of the risks that an AI-led market bubble could burst. Its financial stability report in July only mentioned AI in the context of the risks from the technology’s use by financial institutions.
On Wednesday, the BoE pointed to the cyclically adjusted price-to-earnings ratio for US shares, which measures the earnings yield and has fallen “close to the lowest level in 25 years — comparable with the peak of the dotcom bubble”.
The S&P 500 index of larger US-listed companies is trading at a one-year forward price-to-earnings ratio of 25 times, which is “elevated relative to historical levels” but below levels of the 2000 dotcom bubble, it added.
The BoE said “any AI-led price adjustment” would have a greater impact on investors because of the higher concentration of tech companies in the overall market. The top five tech companies make up an all-time high of almost 30 per cent of the S&P 500.
US credit markets have been shaken in recent weeks by the defaults of subprime auto lender Tricolor and car parts group First Brands, which both relied heavily on loans from private credit providers and invoice financing.
“These underscore some of the risks the FPC have previously highlighted around high leverage, weak underwriting standards, opacity, and complex structures,” the BoE said.
It added that credit market spreads, measuring the difference between interest rates for riskier borrowers and those considered safe, had fallen “close to historically low levels”.
But the BoE sounded more sanguine about the resilience of UK credit markets, saying household debt to income levels were the lowest since 2001 and company debt levels were “significantly below” recent peaks,
while the UK banking system “remained resilient”.
It added that “a number of” UK lenders had taken up the option provided by regulators to provide a higher share of mortgages with high loan-to-income ratios. The FPC is also reviewing the availability of finance for smaller UK companies.