A market correction to tech stock grandiosity in the U.S. is likely and might have far-reaching consequences due to limits in fiscal and monetary policy buffers to blunt the potential economic hit, the European Central Bank (ECB) warned in a blog post on Monday.
Investors have been piling into technology stocks on bets that artificial intelligence will fundamentally alter the global economy, and valuations for top tech companies are now far above historic averages.
"Economic research on past technological revolutions points to a worrisome conclusion: a correction of current stock market valuations is likely," said the blog post, which does not necessarily reflect the ECB's opinion.
Even if the technology succeeds and profits rise, stocks may still fall because it is hard to fulfil markets' excessively optimistic profit growth bets, the post added.
Psychological trends also point to a correction, the blog argued.
Overly optimistic investors tend to bid up prices beyond fundamentals. Then, when optimism fades, prices tend to fall even more sharply than in the rational scenario, the post said.
For Europe, a U.S. market correction would be a question of financial stability since households have a 440-billion-euro ($510 billion) in exposure to so-called Magnificent Seven stocks (Alphabet, Amazon, Apple, Meta Platforms, Microsoft, Nvidia and Tesla), while pension and insurance firms' exposure is about the same.
"The more severe scenario is not the equity correction on its own but a correction that coincides with broader market instability that policymakers cannot easily calm: unlike in the dot-com episode, today's starting point leaves markedly less room to cut interest rates or use fiscal policy to cushion the fallout," the blog said.
While European stock valuations appear more rational, market moves closely correlate with the U.S., so local equities will also take a hit, the blog said, adding that the exact timing of the correction "is unknowable in advance."
"These boom-bust patterns are only identifiable with hindsight," it said.
