ECB economists warn an AI stock correction may be unavoidable

On Monday, five economists at the European Central Bank published something admirable: an argument for why stock prices are probably due for a correction, regardless of whether today's valuations make any sense. It has the usual caveat that "the post reflects the views of its authors, not necessarily the views of the ECB."

That maths suggests a correction either way

Their argument is two placed together. In the rational case, enormous AI equity valuations are rational today because nobody really knows what the upper bound of the return on those investments will actually be, and so paying a premium is justifiable by this uncertainty alone.

This theory investors have used for Nvidia as they bet on it becoming the next Google. Yet, the economists said much of their logic erodes as technology spreads. AI adoption may be confined to a few firms, and its risk is therefore diversifiable. When it's pervasive, that risk becomes systemic, investors start to require a bigger cushion for it, and historically that requirement of a larger buffer tends to outweigh the incremental profit the technology actually provides.

The behaviour case is wobbier: investors get over-confident, start bidding prices past fundamentals, and when that confidence breaks markets do not just correct, they overshoot. When that happens, no one knows. These trends, as the economists put it, "can be discerned only in retrospect."

At present the CAPE (cyclically adjusted PE) looks at US valuations as a percentage of ten years worth of earnings and its level is about 41, or the second-highest reading in history, behind only the dot-com peak around 44 to 45 in late 1999.

This isn't just a problem in America

Now, this is where it specifically starts being a European story. Euro-area households have an estimated €440 billion of exposure to the Magnificent Seven (more from ETF and mutual fund holdings than direct stock ownership, thus many carry that risk without knowing how concentrated such is).

On top of that, pension funds and insurers hold a similar amount. In a hard US tech sell-off, funds facing redemptions normally offload their most liquid holdings first, which pushes prices down and it further fuels more redemptions, and the loop converts a market correction into what in all likelihood could be becoming a real financial stability issue.

So, the economists' strongest message: while a correction is coming, the real risk isn't just price correction but how it lands, when plenty of central banks and governments have little room left to cut rates or spend through their way to safety.

Not everyone's buying the warning

Markets in Europe appear less stretched than those in the US, with lower price to earnings ratios and far less AI-driven excitement baked into prices, which curbs the chance of a home-grown crash hitting there.

The challenge is that US and European markets have tended to move together so a US selloff very rarely stays contained there. The ECB view on timing is NOT universally held either.

Yardeni Research continues to be bullish, upgrading the 2026 S&P 500 target to 8,400 recently, and putting up a 10,000 goal by decade's end, an annualized rate that would represent a fourth consecutive year of 15%+ gains, last seen in the late 1990s. Which is that, most importantly, the very same comparison the ECB economists are drawing as well.

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