The AI rally could be followed by a stock market correction, according to ECB economists

Following a "sharp rally" in the technology sector, a stock market correction is likely, which could have serious consequences for the eurozone, researchers at the European Central Bank warned.

Even if current stock valuations are rational, a pullback should be expected, ECB economists wrote, offering two complementary explanations:

First, as the widespread adoption of AI spreads risks from individual companies across the entire economy, investors will demand higher risk premiums. If earnings growth proves insufficient to offset this, stock prices will fall, the publication states.

Second, economists believe that overconfident and overly optimistic investors drive prices above fundamental indicators until sentiment shifts and valuations are corrected.

At the same time, regulators now have “significantly less room” to respond to market volatility than they did during the dot-com crash: interest rates are lower today, and the scope for fiscal policy is more limited, according to the study.

However, expectations of an inevitable correction do not mean that prices have reached their ceiling: “If AI proves to be a sufficiently transformative factor, valuations could be even higher in the future, even after a correction. It is impossible to know in advance at what stage of this journey we are,” the economists wrote.

The ECB believes that eurozone investors could suffer losses both from direct investments in the stocks of the "Magnificent Seven" companies and from excessive optimism in the region's own stock markets.

"The eurozone’s smaller and less expensive technology sector reduces the risk of a domestic collapse. But that is little consolation: households, insurance companies, and pension funds have significant investments in [U.S. stocks] through global index trackers, and historically, tensions in the U.S. stock market have affected eurozone stock exchanges,” they said.

Economists added that the consequences of the correction in the U.S. could affect sentiment, lending conditions, and hiring.

This article was AI-translated and verified by a human editor