The current market rally, driven largely by AI stocks, is raising concerns about a potential bubble that could lead to a market crash. The S&P 500 has nearly doubled over the past five years, with the “magnificent seven” tech giants accounting for almost 40% of the index, heavily investing in AI technologies. Alongside soaring stocks, other assets like gold, coffee, and Bitcoin have reached record or near-record highs, while home prices continue to climb, making affordability a growing issue. Junk bonds are also trading as if risks are minimal, suggesting widespread optimism that may be disconnected from underlying economic realities.
Economist John Kenneth Galbraith’s classic description of bubbles is relevant today: a new idea sparks enthusiasm, credit expands, prices rise, and eventually reality sets in, causing a crash. Despite typical warning signs like an inverted yield curve—which historically signals recessions within two years—the market has defied expectations, partly due to massive AI-related investments that have kept the economy afloat. This unusual dynamic has created a market environment that feels unstable, with gold’s rise alongside stocks indicating a mix of optimism and fear among investors.
Several key indicators suggest caution. The CAPE ratio, which compares stock prices to inflation-adjusted earnings over ten years, is near 40, close to the internet bubble peak but above its long-term average. Inflation-adjusted gold prices have doubled since 2023, signaling a flight to hard assets amid doubts about paper wealth. Margin debt relative to GDP is at its highest level since 1995, amplifying market movements. The S&P cryptocurrency index has more than doubled since 2023, reflecting crypto’s growing integration into mainstream finance and its potential impact on broader markets.
Housing affordability is another concern, with median home prices now exceeding five times median household income, up from four times in the 1990s. This suggests buyers are stretching financially, and the housing market may be losing its connection to economic fundamentals. Additionally, the high yield credit spread is unusually low, indicating investors are accepting minimal risk premiums for junk bonds, which could signal complacency about potential defaults. Commodity prices like coffee have also surged due to supply issues, highlighting that speculative pressures extend beyond traditional financial markets.
Finally, private markets are showing signs of strain as well. The Morningstar PitchBook Unicorn 30 index, which tracks major private companies like OpenAI, SpaceX, and Stripe, has rebounded to all-time highs after a significant drop in 2022. While AI is inflating public markets, the unraveling of the bubble may begin in private markets. Overall, the combination of soaring asset prices, stretched valuations, and mixed economic signals suggests that while the market rally feels strong, underlying risks and uncertainties could trigger a significant correction in the near future.
