The current equity bull market may be facing a structural challenge, with signs emerging that the AI-driven rally could be entering bubble territory.
Tom Essaye, founder of Sevens Report Research and advisor to some of Wall Street’s largest firms, is warning that the underlying performance of certain key AI-linked stocks is beginning to raise red flags.
While AI remains the dominant market narrative, semiconductor stocks—critical to AI’s infrastructure—have started to lag. This divergence is notable because in prior cycles, sector leaders typically maintained momentum until much later in the rally. The underperformance could suggest that the AI trade, while still powerful, may be losing some of its fundamental support.
Essaye notes that bubbles tend to form in the late stages of an economic cycle, and current macro conditions fit that mold. The U.S. economic outlook is weakening, even as equity valuations stretch to extremes. The S&P 500 sits just off record highs after a 28% gain since early April and an extraordinary 57% surge since ChatGPT’s debut in November 2022. Such rapid appreciation—particularly when concentrated in a single thematic driver—warrants close scrutiny from advisors managing long-term client portfolios.
Investor behavior is also signaling potential excess. Meme stocks are experiencing renewed surges, a hallmark of heightened speculative appetite. More importantly, market valuations in AI-linked names now mirror levels seen before historic collapses, including the 1929 crash and the dot-com bust in 2000. For fiduciaries, this is an important parallel, as both periods were defined by transformative technology narratives that ultimately exceeded reasonable earnings expectations.
In a client note dated August 1, Essaye drew a direct comparison between today’s environment and past bubbles: “Every bubble in modern market history has been based on a narrative, whether it be the internet or real estate. Critically, that given narrative is widely perceived by the investment world to be a source of unlimited earnings growth across most market sectors. Today, that potentially bubble-inflating theme is unquestionably AI technology.”
From a portfolio management perspective, this raises key questions. How much of current equity exposure is tied directly or indirectly to the AI theme? How resilient are these positions if market leadership narrows or sentiment shifts? And most importantly, are clients’ allocations prepared for the possibility of a rapid re-rating in valuations?
Advisors have an opportunity to reassess risk positioning, stress-test portfolios under scenarios where AI-driven gains stall, and consider diversification strategies that can reduce reliance on a single market driver. While the AI revolution may indeed be transformative in the long term, the near-term reality is that markets can price in too much, too quickly. History suggests that when expectations detach from fundamental earnings growth, the correction that follows can be swift and severe.
The takeaway for RIAs: capture upside participation where appropriate, but ensure clients’ portfolios are not overly exposed to a narrative that may be approaching its speculative peak.
