Is a market crash on the horizon? The AI-fueled rally in US stocks could unwind, and an impending bust could impact global markets. The Nobel Prize-winning economist Robert Solow's famous 1987 quote, "The computer age was everywhere, except for productivity statistics," highlights the perceived lag in productivity growth during the 1970s and 1980s, despite the computing revolution's advancement. The Solow Paradox was partially resolved in the 1990s when sectors like technology, retail, and sales accelerated US productivity growth, leading up to the dot-com bust. Now, nearly 40 years later, the Solow Paradox resonates with the emergence of artificial intelligence (AI). While AI's transformative impact on society is undeniable, the question remains: when will it translate into tangible productivity gains in the short term? In Silicon Valley, concerns are growing about the rapid rise in AI tech company valuations, the use of "financial engineering," and "circular deals," and the increasing comparison to the dot-com crash. Experts warn of a potential bubble, with Amazon founder Jeff Bezos stating that an AI bubble is real but its societal impact will be significant. So, is a stock market crash imminent? Record-high valuations On Thursday, the S&P 500 and the Nasdaq hit new highs, while the Dow has surged by 10% year-to-date. This surge is primarily attributed to the skyrocketing valuations of the 'magnificent seven' tech giants: Nvidia, Microsoft, Apple, Alphabet, Amazon, Meta, and Tesla. Their combined market value of nearly $21 trillion exceeds the European Union's output. The S&P 500's price-to-earnings ratio, a key indicator of valuation, was around 23 times in late September, surpassing its 10-year average of 18.7 and approaching the 25-level seen in the early 2000s. The AI-focused tech stock rally, while impressive, raises concerns about market excess. The AI tools' potential applications are still distant, and monetization is a long-term prospect. The surge in valuations is driven by capital influx, anticipating future potential, rather than immediate productivity gains. The Solow Paradox, which once explained the productivity lag in the 1970s and 1980s, is not yet a factor in the current AI-driven rally. However, the market seems to be ignoring significant threats, including the US President's challenge to the global trading system, immigration drop, attacks on the US Federal Reserve's independence, institutional erosion, inflationary pressures, and the government's mounting debt burden. These structural issues are being overshadowed by AI optimism. The market anticipates a substantial productivity boost, but the timeline of these expectations may differ from the actual productivity gains. This discrepancy could trigger a market crash, with whispers of an impending crash already circulating. Growing concerns International Monetary Fund chief Kristalina Georgieva and JPMorgan Chase CEO Jamie Dimon have warned of potential global economic risks due to stock market valuation corrections. Nassim Nicholas Taleb, an author and statistician, advises investors to be cautious about the stock market's record rally, as a growing debt crisis could lead to a major reckoning. These warnings echo Alan Greenspan's 1996 speech, where he questioned asset value escalation due to irrational exuberance, leading to market crashes worldwide. The AI revolution, while promising, faces challenges in translating into monetizable figures that boost company balance sheets. AI companies are incurring significant cash burn as they shift to inference, a process 10 times more energy-intensive than regular search queries. Financial reengineering deals, like the circular deals between Open AI and AMD, further fuel the boom, despite the companies' overvaluation. The fear of missing out (FOMO) is gripping markets, with fresh money chasing high stock valuations. However, this ignores the potential leadership of countries like China and India in the AI application stage. The US, despite shrugging off fundamental concerns, is witnessing bond market troubles in countries like France and Japan. The US deficit is higher than in these countries, but the US bond market implicitly bets on a productivity miracle due to AI. A potential crash could be triggered if markets realize this isn't materializing. The surge in gold and silver investments hints at market uncertainty. A crash in American stocks and bonds could have a global impact, affecting markets worldwide, including India, which has seen flat stock markets in the last 12 months. India's fiscal health might provide some insulation, but a global valuation crash could still devastate most markets. The signs of an impending crash are mounting, and the question remains: is a market crash inevitable?
