US stocks weather mini-bubbles, S&P 500 just 1.6% below record

The S&P 500 sits 1.6% below its record as sector bubbles from memory chips to AI stocks burst without denting the broader rally.

"The banking system is in rude health," said Russell Napier, global macro strategist and keeper of the Library of Mistakes, an Edinburgh-based collection of books on financial history. "That means there's always more credit to do the next bubble."

The equal-weighted S&P 500 — a measure of the average stock in the index — hit a new high this past week, even as the memory-chip bubble inflated and popped in just four months, with SK Hynix dropping 55 percent before Friday's bounce. U.S. equity ETFs are projected to rake in $1.4 trillion in net inflows during 2026, nearly half a trillion more than last year's record, while margin debt stands at $1.5 trillion.

The danger zone lies ahead: estimates of $7 trillion to be spent on data centers over the next four years could seriously damage the economy if productivity gains don't justify the investment, and the increasing use of debt financing means an AI bust could hit the financial system in ways prior mini-bubbles did not.

The post-financial-crisis era of easy money has produced repeated booms and busts in small parts of the market over the past 15 years, none of which stopped the market's relentless rise. The list includes 3-D printing (down 93 percent from peak in 2014), China-related stocks (down 47 percent in 2015), low-volatility products (down 92 percent in a day in 2017-18), SPACs, clean energy, cannabis, space and crypto (Ark Innovation ETF lost 81 percent in 2021), tiny companies with AI hopes (Super Micro Computer and Allbirds, renamed NewBird AI and now Smartbird, both down more than 85 percent), crypto treasury stocks (Strategy down 83 percent), and Trump-related stocks (@DJT down 89 percent).

The memory-chip bubble inflated and popped in just four months, complete with wild volatility and an imploding hedge fund. Trillions of dollars were created out of thin air and then eviscerated. For the rest of the market, it just didn't matter.

The reason these mini-bubbles haven't crushed growth is that they haven't, mostly, been financed with debt. When they burst, investors lost money but the financial system was fine. The misallocation of capital in bubbles is the subject of much debate among economists: Was it better for the economy to build railroads quickly alongside massive losses for investors, or would a slower, more financially rational build-out have been better?

The $7 Trillion AI Question

The current danger area comes from the money being poured into artificial intelligence. Estimates of $7 trillion to be spent on data centers in the next four years are enough to seriously damage the economy if productivity gains aren't big enough to justify it. And the increasing use of debt financing means that if AI more broadly turns out to be a bubble, it could hit the financial system, too.

The get-rich-quick desire never goes away, but the gamification of trading and zero-fee commissions made it easier to gamble on stocks than ever. Innovation, both financial (2018's "vol-mageddon" and 2021's SPACs) and technological (behind excitement about crypto, 3-D printing, AI, clean energy and space), seems to be coming more frequently than usual.

Tech titans like Nvidia and Microsoft are at the forefront of the AI investment frenzy, their insatiable demand for capital spending driving much of the current market enthusiasm. Some strategists point to the narrowness of the rally — where a handful of mega-cap tech stocks disproportionately drive index gains — as a vulnerability if those specific companies falter.

One day the bust will be the big one and drag down the whole market. But for now, at least, the pullback in AI-related stocks has been almost completely offset by gains elsewhere. The Dow added nearly 550 points on strong earnings as oil prices sank, while chip stocks weighed on the Nasdaq.

This article is for informational purposes only and does not constitute investment advice.