This important AI-Stock index is sending potential bubble signals

It is currently one of the biggest mysteries on the market. Is AI trade a stock market bubble?

The revenue remains impressively strong, but there are potential warning signs for the bubble. The S&P 500 is nearing its all-time high, earning 57% since the announcement of ChatGPT in November 2022 after a 28% rally from early April.

The meme stocks are ripped, suggesting an abnormal rise in investor sentiment. Excitement around AI has encouraged market valuation to levels consistent with previous major bubbles, as seen in 1929 and 2000.

Sevens founder Tom Essaye recently covered the topic in several client notes, including advisors from Wall Street's biggest companies.

“Every bubble in modern market history is based on narratives, whether on the internet or on real estate. Critical, the narrative is widely recognized by the world of investment and is widely recognized as a source of unlimited revenue growth across most market sectors,” he wrote in a note on August 1. “AI technology is definitely the subject that potentially bubbles are today.”

As Essaye sees, the best way to measure the health of AI trade is to look at how semiconductor stocks behave overall, as chips are the lifeblood of AI technology. He said this can be done using the PHLX Semiconductor Index (SOX), a group of 30 shares.

When comparing the index's performance over the past few years with the S&P 500, “There's a serious problem with this bull market for this stock,” he said.

Essaye's concern is that the S&P 500 has risen nearly 14% in the meantime, while Sox is below its July 2024 high. This suggests that market gatherings, primarily fueled by AI narratives, could be in unhealthy places if many AI stocks themselves cannot maintain momentum.

“The point here is that if AI is the main source of bullish optimism for continued gatherings in the broader stock market in the coming months and quarter, this market is in trouble and that Sox should lead the market faster, as it was in 2024 and not quite behind the last 12 months,” he writes. “That difference in index performance makes sense. If Sox rolls in weeks or months and essentially starts selling, the S&P 500 is almost certainly not behind.”

This is the performance of ETFs that track SOX indexes over the past three years.

and S&P 500 performance:

Another sign of a potential bubble, and perhaps a future trouble due to stocks, is that the US economic outlook appears to be weakening, the essay said.

Bubbles usually form later in the economic cycle, the essay said, and the recession usually bursts them.

As salary data released on August 1st showed, causing fear of a recession, employment benefits over the past few months have been poor. He said the claims of unemployment are creeping up.

In a memo on August 8, the essay wrote, “It's important to keep tabs close to economic data right now,” adding that “it was raised in the wake of a rapid ~85% trough-to-peak rally on the S&P 500.”