On Monday, five economists from the European Central Bank published an analysis arguing that stock market valuations are likely to correct, and that this argument holds true regardless of whether today's prices are rational or not.
The article by Malin Andersson, Johannes Breckenfelder, Stefano Corradin, Kalina Nikolova, and Maria Antoinette Viola states that the valuation of U.S. companies based on the CAPE ratio (a metric comparing stock prices to inflation-adjusted average earnings over the past decade) is near its historical peak.
In the eurozone, prices have also risen, albeit to a lesser extent. Studies of past technological revolutions, the economists write, point to a "disturbing conclusion."
The views expressed in this article are the personal opinions of the authors and do not necessarily reflect the position of the ECB.
Rational valuations and investor optimism point to the same outcome
This post presents both a rational and a behavioral explanation. According to the rational explanation, extreme uncertainty regarding the effectiveness of a new technology would be reason enough to justify a very high valuation of its stocks, as there is little to lose from testing it, and it is impossible to determine its growth limit. This asymmetry creates an option value that increases the price-to-earnings ratio for early adopters of the technology.
The economists cite Nvidia as an example of a company whose logic, in their view, is that it will become the next Google. This theoretical model is based on research by Luboš Pástor and Pietro Veronesi conducted in 2009.
Prices could still fall. While the technology is used by only a few companies, failure can be diversified away. As adoption spreads, the same uncertainty becomes macroeconomic and can no longer be diversified, so investors demand a higher risk premium. Earnings do not necessarily have to fall for prices to fall as well. Adoption helps increase cash flows, but historically, a rising premium persists unless earnings growth is strong enough to offset it.
The behavioral approach is closely related: overconfident investors place bets exceeding fundamentals, and once this overconfidence wanes, the market can crash even harder. "The precise timing cannot be predicted in advance," the economists state, and "these sequences can only be identified retrospectively."
Eurozone household investments in the US tech sector amount to €440 billion
Most investments in the "Magnificent Seven" within the eurozone are made through mutual funds and exchange-traded funds (ETFs), rather than by directly acquiring stocks. Households, increasingly directing funds into low-cost ETFs, hold around €440 billion worth of investments in U.S. technology stocks in their portfolios, not always aware of the concentration risk.
Insurance companies and pension funds also hold significant positions. The position data takes into account information as of the third quarter of 2025.
The fund structure itself is a transmission channel. A market correction could force funds to liquidate to meet redemption requests, starting with the most liquid assets and ending with troubled ones, leading to price declines and further redemptions. This is why the economists consider a market correction in the "Magnificent 7" a financial stability issue for the eurozone.
"The real risk," they say, "is not only a stock market correction, but that it occurs in an environment where authorities have much less room than usual to use monetary and fiscal policy to mitigate its impact."
Situation in Europe appears less stretched than in 2000, but remains vulnerable to US asset sell-off
The article argues that the likelihood of an internal crash appears lower. Price-to-earnings ratios in the eurozone remain significantly lower than in the U.S., productivity and profit margins in the information and communication technology sector are rising, and the business climate for digital services in the eurozone does not appear optimistic.
AI adoption by companies has grown noticeably several years after the launch of ChatGPT in 2022, and digital investments in the region have grown more than three times faster than aggregate GDP growth over the past decade.
As Cryptopolitan reported in December, the ECB also drew a comparison with the dot-coms in its Financial Stability Review, and Morningstar's chief equity strategist Michael Field noted that the "Magnificent Seven" accounted for 40% of the Morningstar US Index.
However, a limiting factor for such defense is correlation. U.S. and eurozone stock markets have traditionally moved in sync, and the economists forecast that an AI-related debacle in the U.S. will remain a problem not just for the U.S.
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