Volatility suggests AI is not in a bubble — at least not yet, says Bank of America

Bank of America derivatives strategists argue that the current AI stock rally is not yet a bubble, citing the absence of rising volatility, a consistent characteristic of historical asset bubbles. They note the S&P 500's one-month realized volatility recently fell to 8.5%, and megacap tech stocks have rallied without increased volatility, unlike earlier in Q1. However, BofA identifies "signs of froth" in other market segments like Robinhood and Coinbase, suggesting the potential for the AI bubble to continue inflating, possibly with a focus shift from megacaps, indicating that bubbles can unfold over years and this could be an early phase.

Analysis

Bank of America's derivatives strategists posit that the current artificial intelligence rally is not exhibiting the characteristics of a classic asset bubble, primarily due to the absence of rising volatility. Historical analysis of nine major bubbles over the past century shows that rising asset prices were consistently accompanied by increasing volatility, a dynamic not currently present. One-month realized volatility in the S&P 500 recently fell to a yearly low of 8.5%, and the index has experienced 18 consecutive days without a move of 1% or more. This divergence is also evident in megacap technology stocks like Nvidia and Apple, where recent price appreciation has occurred without a corresponding rise in volatility, a notable shift from the "spot-up, vol-up" tendencies observed in Q1 2024. However, the analysis does not rule out a future bubble, noting the dot-com era also had periods of calm. Strategists identify "signs of froth" in other market segments, including Robinhood (HOOD) and Coinbase (COIN), suggesting speculative energy may be rotating away from megacaps. This indicates the market retains the potential for a broader AI bubble to inflate over time, and we could still be in the early stages, well before the widespread participation and surging volatility that typically mark a bubble's final phase.

Key Decisions for Investors

• Given the current low-volatility environment in megacap tech, investors may find justification for maintaining core AI-related positions, while closely monitoring for any return of the 'spot-up, vol-up' dynamic seen in Q1 as a potential warning sign.
• Exercise heightened caution and monitor for signs of excess in peripheral, high-beta names like Robinhood (HOOD) and Coinbase (COIN), as these are identified as pockets of 'froth' that could signal broader shifts in speculative sentiment.
• Adopt a long-term perspective, recognizing that the market may be in the early innings of a multi-year AI cycle, and use realized market volatility as a key gauge to assess when the rally could be transitioning into a more precarious, late-stage bubble.