In the ever-evolving landscape of technology and finance, the question of whether artificial intelligence (AI) is experiencing a bubble akin to historical tech booms has been a topic of heated debate. However, recent insights from Bank of America’s (BofA) derivatives team suggest that while AI is attracting significant attention and investment, it may not yet qualify as a bubble if we consider volatility metrics.

Understanding Asset Bubbles and Volatility

To understand BofA’s perspective, it’s crucial to grasp the relationship between asset bubbles and market volatility. Historically, asset bubbles are characterized by rapidly rising asset prices that detach from underlying fundamentals, eventually leading to sharp corrections. Volatility, the measure of price fluctuations in the market, tends to rise in tandem with asset prices as uncertainty and speculation increase.

Here are the key points from BofA’s derivatives team on why AI is not yet in bubble territory:

1. Volatility and Asset Prices: A Symbiotic Relationship

Rising volatility, when coupled with soaring asset prices, is a hallmark of an asset bubble. In the context of AI, while asset prices in the sector have indeed been climbing, the anticipated spike in volatility has not followed suit. This indicates a more stable market environment compared to typical bubble scenarios.

2. Fundamentals and Their Role in Market Dynamics

A significant red flag for bubbles is when asset prices become untethered from fundamental values. For AI, despite high valuations, there is a substantial alignment with fundamentals, driven by real advancements and broad applications across industries. This alignment helps temper volatility and maintains a connection between price and intrinsic value.

3. Historical Precedents of Asset Bubbles

Looking back at nine major asset bubbles since the 1920s, a common theme emerges: increased volatility preceding market peaks. This historical analysis shows that in bubbles, volatility rises as investor sentiment becomes overly optimistic and speculative. In contrast, the current AI sector has not exhibited a corresponding increase in volatility, suggesting a more measured market.

4. US Equity Momentum and Its Implications

Earlier this year, US equity momentum reached levels not seen in nearly a century. This remarkable performance raised eyebrows and led to comparisons with previous bubble environments. However, this momentum has been driven largely by a small group of technology stocks rather than a widespread speculative frenzy, further mitigating bubble concerns.

5. The Influence of the “Magnificent 7”

The dominance of a select few US tech giants, often referred to as the “Magnificent 7,” has sparked fears of a potential bubble. These companies have driven significant market gains, leading some to worry about market concentration. Despite these concerns, the tech sector has not seen the volatility spikes typical of bubble conditions, indicating a more stable growth trajectory.

6. Tech Volatility: A Key Indicator

One of the clearest signs that AI is not yet in a bubble is the lack of a significant rise in technology sector volatility. BofA’s analysis points out that despite high valuations, the stability in tech volatility suggests a more balanced market outlook, driven by real earnings growth and innovation rather than speculative excess.

7. Return Dispersion and Valuations Compared to the Late ’90s

Comparing current market conditions to the late 1990s dot-com bubble, BofA notes that return dispersion and valuations show fewer signs of frothiness today. During the dot-com boom, extreme valuations and wild price swings were common. In contrast, today’s tech sector, including AI, is characterized by more rational valuation levels and relatively contained price movements.

AI’s Balanced Growth

While the AI sector is experiencing rapid growth and substantial investment inflows, the evidence from BofA’s derivatives team suggests that it is not yet in bubble territory. The lack of significant volatility increases, coupled with alignment with fundamental values and controlled market dynamics, supports a view of measured growth rather than speculative excess.

Investors should remain vigilant, as markets can evolve quickly, but for now, the AI sector appears to be on a sustainable path, driven by real-world applications and technological advancements.