Market valuations have “become stretched”, increasing the probably of a “disorderly correction”, the International Monetary Fund (IMF) has warned.
In its latest Global Financial Stability update, published alongside its half-year report on the global economy, the Washington-based fund highlights the concentration risk within the US’s S&P 500 index from the so-called magnificent seven stocks (Alphabet, Amazon, Apple, Microsoft, Meta, Tesla and Nvidia).
It noted that the information technology sector accounted for a weight of 35 per cent of the total S&P 500, similar to during the dot-com bubble of the 1990s, but this time just seven stocks accounted for 33 per cent of the index.
That meant the concentration risk “was now substantially higher than during the dot-com bubble”.
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Many analysts believe stock markets, particularly in the US, are on the brink of major negative correction following an investment glut in artificial intelligence (AI).
AI-related companies have accounted for around 80 per cent of US stock market gains this year.
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In its report, the IMF said the rebound in global equity prices since US president Donald Trump’s April tariff announcement had outpaced expected future earnings.
Despite recent economic data trending negative, markets appear to be downplaying the potential effects of US tariffs on growth and inflation, it said.
Global financial markets “have largely brushed off subsequent shocks and uncertainties,” it said, noting financial conditions across most regions have eased back to “accommodative levels”.
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But it warned “the apparent calm masks a degree of complacency.”
“Despite trade tensions, geopolitical uncertainties, and rising concerns about sovereign indebtedness, asset prices have returned to stretched valuations and financial conditions have broadly eased,” it said.
“Against substantial AI-related investments, the possibility of mega-cap stocks failing to generate expected returns to justify current lofty equity valuations could trigger deterioration in investor sentiment and make the stocks susceptible to sudden, sharp correction,” the IMF said.
An analysis of sovereign bond markets also highlighted “growing pressure from widening fiscal deficits on the functioning of markets,” it said.
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In advanced economies, sovereign bond markets are increasingly dependent on price-sensitive investors, it said.
“Stress in core bond markets, although a tail risk, could have broad and disruptive ramifications for financial markets, given bonds’ role as key benchmarks and collateral,” it said.
In its report, the IMF also highlighted the weakness of the US dollar
“Overall, the dollar has depreciated by about 10 per cent so far this year against major currencies,” it said.
“Analysts have put forth a number of possible drivers for dollar weakness, from a revaluation of dollar strength amid concerns over the US fiscal position to a shift in allocation away from US-dollar-denominated assets driven by concerns about US policy uncertainty,” it said.
