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Anthony Rowley

As economist Paul Sheard noted in his book The Power of Money, money is created not only by the fiat of governments or central banks but also by commercial banks. Relatively few people are aware of this fact, but fewer still realise that stock markets also can create “money” in the form of purchasing power.
Thus, any collapse in stock prices of the kind which appears increasingly imminent now represents both the destruction of “paper wealth” and of real wealth that supports economic activity. This warrants serious thought at a time when the global economy is looking fragile.
Stock market crashes have come and gone over decades leaving in their wake financial distress before eventual recovery. The scale of the next one will exceed anything seen in the past when it happens.
As Reuters markets columnist Jamie McGeever noted this week, US and world stocks have touched new highs as artificial intelligence (AI) fever continues to outweigh the prolonged US-Iran impasse, but “the ceasefire is fragile and hopes of a lasting deal appear to be fading”. Stock market concentration, he added, “is near record levels in the US and across emerging markets. Should investors be worried? Not necessarily, although it could get messy once the drawdown finally gets under way.”
The cause for particular concern now is that the total value of exchange-listed stocks – those of AI and some tech companies especially – have been elevated to unprecedented heights of tens of trillions of dollars, creating new levels of imputed wealth.
What does this mean? Putting it simply, the value of shares is largely in the eye of the beholder, meaning that of the market or the individual investor. It depends on how much the investor believes the companies in which they invest are capable of earning in a given period.


This is not the same thing as saying it depends on what the investor believes the company will distribute by way of dividends during that time – something fairly easily calculated from the past payout record. The calculation also depends upon investor and market confidence at any given time. Right now, investors appear highly confident about what leading AI companies are capable of earning well into the future, a fact which allows their shares to command a high price-to-earnings (P/E) ratio.
At such times, investors do not base the price they are prepared to pay for a share on current earnings or after-tax profits per share but on assumed future earnings. Herein lies the potential for inflated stock prices. For example, if investors feel the future profit or earnings potential of the companies they invest in is good for 20 years from now, they will be happy to pay 20 times annual earnings per share.
This is not a scientific or actuarial calculation. It depends on the extent to which the profit outlook of particular companies or sectors is hyped, or at least widely publicised rather than being coldly calculated.

There is a widespread belief at present that AI is likely to transform business and economic activity, especially in the developed world. However, this somewhat intangible benefit is not calculated against the more predictable cost of the infrastructure and energy needed to support the data centres required by AI.
As a result, there is the risk to the inflated valuations of glamour stocks should actual returns from AI investment fall short of projections of capital investment needed to support the boom. A major sell-off of stocks could occur in such an eventuality, a prospect increasingly hinted at by more informed commentators.
The risk of a stock market crash, in the US market especially, is by no means limited to a single sector. In late April, it was estimated that AI stocks represented almost 45 per cent of the total capitalisation of the benchmark S&P 500 index. Any major damage to investor confidence about the AI revolution would be a setback for nearly half of the US market and would hardly represent an opportunity to “buy the dip” because the dip could take the form of a market collapse.

More important is the impact that all this would likely have on the real economy. A rise in stock investment values (paper wealth) becomes real wealth by virtue of the fact that it influences perceived wealth and the ability to leverage spending, capital investment and borrowing using stocks as collateral.
This is borne out by the fact that the dramatic increase in stock valuations in recent years has been accompanied by an accompanying increase in debt at the household, corporate and government levels. The ensuing supercharged rise in debt to often record levels has also been aided by a decade or more of very low – zero or even negative in some cases – interest rates, which was then reversed as monetary policy underwent general tightening amid the threat of inflation.
So please, let us have more commentators refrain from facile comments about the resilience of stock prices and of the global economy until such time as such optimism is justified. That will probably be around the end of this year given the growing consensus among observers that the impact of the crisis in the Middle East and its ripple effects are likely to persist at least that long.


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Opinion

World Opinion

Economy

Global Economy

Hype around AI and some tech companies has inflated stock prices and left investors ebullient despite the rising risk of a market crash


Hype around AI and some tech companies has inflated stock prices and left investors ebullient despite the rising risk of a market crash.


Artificial intelligence (AI)

Macroscope

Middle East

United States

Standard & Poor's (S&P)

Expresses the views, ideas and conclusions of the author. (Eg. Enough of Crazy Rich Asians, think of crazy poor Hongkongers.)


Column

Global stock markets are bubbling along on unjustified optimism

.css-1c6uqr6{color:inherit;font-weight:inherit;font-size:inherit;font-family:inherit;line-height:inherit;overflow-wrap:break-word;}Hype around AI and some tech companies has inflated stock prices and left investors ebullient despite the rising risk of a market crash

Hype around AI and some tech companies has inflated stock prices and left investors ebullient despite the rising risk of a market crash