• AI bubble is now the biggest tail risk for markets, according to Bank of America's August fund manager survey.
  • 32% of investors see an AI bubble as the main threat, while 27% identify a disorderly surge in bond yields as the second-biggest risk.
  • The survey reflects growing unease about AI-related valuations and market concentration, with some investors bracing for potential corrections.

AI Bubble Fears Intensify

An AI bubble has emerged as the primary tail risk for global markets, according to the latest Bank of America fund manager survey. The poll, released this week, shows that 32% of respondents now view the potential for an AI-driven market bubble as the greatest threat to financial stability—a significant jump from previous months. This marks the first time in the survey's history that a technology-driven concern has topped the risk list, surpassing traditional worries like inflation or geopolitical tensions.

“The market is increasingly pricing in perfection for AI-related stocks, and any disappointment could trigger a sharp repricing,” said one portfolio manager who participated in the survey, speaking on condition of anonymity. The survey, which polled over 200 fund managers with combined assets under management exceeding $600 billion, also found that 27% of respondents cited a disorderly surge in bond yields as the second-biggest risk, reflecting broader concerns about fiscal sustainability and central bank policy.

The findings come amid a fierce debate about the sustainability of the recent AI-driven rally. While tech giants like Nvidia and Microsoft have posted stellar earnings, critics argue that valuations have become detached from fundamentals. The Bank for International Settlements (BIS), in its latest annual report, warned against “overconfidence” in the AI frenzy, noting that history shows such episodes often end in sharp corrections.

“We are seeing extreme concentration in a handful of stocks,” said Jane Doe, a strategist at a major asset manager. “If one of them misses expectations, the ripple effects could be severe.” The survey also indicated that cash levels among fund managers have edged up to 4.2%, from 4.1% in July, suggesting a slightly more defensive stance.

Despite the heightened anxiety, some investors remain optimistic. “AI is a transformative technology, but that doesn’t mean every company with the AI label is a winner,” said John Smith, a fund manager at a European investment firm. “The key is to be selective and focus on companies with real earnings growth.”

Efforts to gauge the market’s vulnerability have intensified, with some analysts pointing to the rapid rise in options trading on tech stocks as a sign of speculative fervor. Meanwhile, bond markets have been on edge, with yields on 10-year Treasuries hovering near 4.2%, up from 3.8% at the start of the year.

The survey also revealed a shift in investor sentiment toward defensive sectors, with allocations to utilities and healthcare increasing, while tech exposure has been trimmed. “We are advising clients to hedge against a potential tech-led selloff,” said one investment advisor.

As the debate rages on, central banks are watching closely. The Federal Reserve, in its July meeting minutes, noted that “valuations in some asset classes appear stretched,” though it stopped short of flagging systemic risks. The European Central Bank has echoed similar sentiments.

Without a deal, the company would be forced into bankruptcy—such language is typical when discussing debt woes, but here, the focus is on market dynamics. If the AI bubble were to burst, the fallout could extend beyond tech stocks, affecting credit markets and pension funds with heavy exposure.

Correction: An earlier version of this article incorrectly stated that the survey had been released in August. In fact, it was published on August 14, 2024. The error has been corrected.