Ruchir Sharma: The four ‘O’s that shape a bubble

And what this test tells us about the artificial intelligence waveAuthor of the article:You can save this article by registering for free here. Or sign-in if you have an account.The writer is chair of Rockefeller International. His latest book is ‘What Went Wrong With Capitalism’Subscribe now to read the latest news in your city and across Canada.Subscribe now to read the latest news in your city and across Canada.Create an account or sign in to continue with your reading experience.Create an account or sign in to continue with your reading experience.Amid the chatter about artificial intelligence mania, people have begun to joke about “a bubble in bubble talk.” Google searches for AI with the b-word have surged and the mood in the markets feels exuberant, but beyond these soft indicators there is no standard measure of a bubble. My test focuses on four Os: overvaluation, over-ownership, over-investment and over-leverage. Here’s how AI scores now:Get the latest headlines, breaking news and columns.By signing up you consent to receive the above newsletter from Postmedia Network Inc.A welcome email is on its way. If you don't see it, please check your junk folder.The next issue of Top Stories will soon be in your inbox.We encountered an issue signing you up. Please try againInterested in more newsletters? Browse here.In major bubbles going back to gold in the 1970s and the internet boom of the late 1990s, inflation-adjusted prices rose 10-fold over 10 to 15 years. U.S. tech shares recently hit that threshold. Further, a study of bubbles over the past century shows that the probability of a crash rises to more than 50 per cent when the industry at the heart of a mania beats the market by more than 100 per cent over two years. AI-related stocks are near that tipping point, too.These dramatic price increases have pushed long-term valuations of U.S. stocks close to the highest levels in history. Some say this doesn’t matter, because AI will boost growth more dramatically than previous tech revolutions, and valuations were more extreme in 1999-2000. But if history is any guide, then valuation and prices are flashing a deep-red bubble warning.This measures how much money is flowing into the hot new thing. And Americans are furiously chasing stocks, particularly in tech. Households hold a record 52 per cent of their wealth in stocks, which is higher than the peak in 2000 and far above levels in the EU (30 per cent), Japan (20 per cent) and the U.K. (15 per cent).A closely related signal is overtrading. Over the past five years, the number of shares traded each day in the U.S. has risen by 60 per cent to around 18 billion. The retail share of short-dated stock options has grown from a third to more than half. Young people are succumbing to “financial nihilism” — indulging in speculation because they have given up on buying a home.If the stock market drops on a given day, retail investors impulsively buy the next day. Their favourites are clear: on the Robinhood platform, the five most heavily owned stocks are all in the Magnificent Seven. And with US$7.5 trillion still sitting in money market mutual funds, small U.S. investors may have buying power left.Because financial conditions remain so loose, liquidity keeps driving up stocks. That is almost forcing institutional investors to keep buying, including many who are sceptical of AI euphoria. The result is a strange new animal: the fully invested bear.AI enthusiasts say incessant bubble talk proves this is not a bubble, because peaks come when worry is gone and optimism is universal. Perhaps, but worry was in fact growing before the dotcom crash. One year earlier, the San Francisco Fed raised the spectre of 1929. Many columnists and economists echoed those fears, as did several institutional investors. Just like today. Tech investment recently surpassed 6 per cent of U.S. GDP, topping the record set in 2000. Companies are pouring capital into AI data centres, and power plants to run them, led by the hyperscalers. Counting just the Magnificent Seven, AI spending has more than doubled since 2023 to US$380 billion this year and is on track to exceed US$660 billion by 2030. The potential returns are far from clear. For every survey that says demand for AI is skyrocketing, another shows the opposite: fewer than 15 per cent of US companies say they use AI, amid multiple signs that the adoption rate is slowing down.Techno-optimists say AI investment will pay for itself by cutting labour costs, replacing up to 40 per cent of tasks now done by humans “in the not very distant future”, and pushing jobless rates as high as 20 per cent. Will humans sit by while this unfolds? Labour disruption on this scale could trigger a political backlash, limiting the degree to which AI investment pays off.So far, corporations and households in the U.S. do not look overleveraged. But the Magnificent Seven are not the cash machines they were even a year ago. Amazon.com Inc., Meta Platforms Inc. and Microsoft Corp. are now net debtors, up from one in 2023. Their profits continue to rise but with so much flowing into AI, only Google and Nvidia Corp. still generate piles of cash.This time, the debts are building on the government ledger, thanks to record deficits — a major risk. If bond investors come to question America’s shaky finances, they could push up long-term interest rates, which would reverberate across the economy.Meanwhile, in the financial markets leverage has moved beyond old-school margin loans for individual stock purchases. Now there are funds that borrow money to magnify their bets. These “leveraged ETFs” are readily accessible to retail investors, and have seen their assets grow by a factor of seven over the past decade to around US$140 billion.Tallying up, to varying degrees all four of the Os suggest AI is a bubble, and it has reached an advanced stage. However, history also shows that there is no exact point at which a bubble bursts under its own weight.The one constant trigger for a crash, going back to the railroad bubbles of the 19th century, has been rising interest rates and tightening financial conditions. So while we are clearly in a bubble, it could keep growing until the money inflating it starts drying up.© 2025 The Financial Times LtdPostmedia is committed to maintaining a lively but civil forum for discussion. Please keep comments relevant and respectful. Comments may take up to an hour to appear on the site. You will receive an email if there is a reply to your comment, an update to a thread you follow or if a user you follow comments. Visit our Community Guidelines for more information.