The Odds of an AI Bubble-Bursting Event Appear to Be Sharply Rising
More than 30 years ago, the advent and proliferation of the internet changed corporate America forever. For decades, investors have waited, often impatiently, for Wall Street's next "internet moment." Artificial intelligence (AI) has answered the call.
The evolution of generative AI and large language models, coupled with the otherworldly amount of capital spent on the AI infrastructure build-out, has lifted the Dow Jones Industrial Average(DJINDICES:^DJI), S&P 500(SNPINDEX:^GSPC), and Nasdaq Composite(NASDAQINDEX:^IXIC) to new heights.
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While few Wall Street analysts doubt the long-term addressable opportunity that AI brings to the table, the odds of an AI bubble-bursting event appear to be rising by the day .
Image source: Getty Images.
Election Night presents a new challenge to the AI data center build-out
For the most part, midterm elections went as forecast. Democrats retook both houses of Congress, setting up the potential for political gridlock in the final two years of President Donald Trump's second nonconsecutive term.
But one aspect of Election Night came as a big surprise to AI investors. Namely, Democratic gubernatorial candidates flipped at least five seats previously held by Republicans (two governorships remain uncalled by the Associated Press, as of Nov. 6).
Whereas President Trump has pledged to minimize AI regulation and has threatened to use his veto power to maintain the status quo on Capitol Hill, his veto won't affect state-level changes enacted by Democratic-led governors.
Three of the flipped governorships include Texas, Georgia, and Ohio, which are three states focal to AI data center planning and construction. Governor-elect Gina Hinojosa of Texas has vowed to put a moratorium on new data center approvals until her state's legislature passes laws governing electricity and water rights, among other factors.
Any slowdown in the AI data center build-out in foundational states could be a significant blow to the AI-driven bull market.
Fed Chair Kevin Warsh has cautioned about more challenging lending conditions within the AI arena. Image source: Official Federal Reserve Photo.
Lending conditions are tightening for neoclouds
Secondly, we're seeing evidence that lending conditions are tightening for neoclouds (and even some hyperscalers).
Following the Federal Open Market Committee's (FOMC) Oct. 28 meeting, Fed Chair Kevin Warsh made an intriguing assessment of credit markets. In response to a reporter's question about the inflationary effects of AI on the U.S. economy, Warsh stated:
Interest rates have had an effect. You've seen market participants that are discriminating between the kinds of investments they want to make. You've seen credit spreads for certain assets widen out, gap out.
In other words, the head of the central bank is telling investors that borrowing conditions for neoclouds are becoming less favorable. To boot, a recent deterioration in corporate bond prices for neoclouds and some hyperscalers backs up Warsh's claim.
The stock market is historically pricey, with no margin for error
Last but certainly not least, the stock market entered 2026 at its second-highest valuation in 156 years, according to the S&P 500's Shiller Price-to-Earnings Ratio, leaving equity markets with no margin for error.
History shows that the Shiller P/E has exceeded 30 during a continuous bull market six times over the last 100 years, including the present. The previous five occasions were all followed by declines of 20% or more in the Dow, S&P 500, and/or Nasdaq Composite.
The takeaway is straightforward: premium valuations aren't sustainable over the long run on Wall Street.
With structural headwinds mounting for neoclouds and hyperscalers, it wouldn't take much to tip a historically pricey stock market over the edge.
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The Odds of an AI Bubble-Bursting Event Appear to Be Sharply Rising was originally published by The Motley Fool
