For all the hand-wringing about the existential danger to humanity posed by AI, markets may still be mispricing the risks of a doomsday scenario — or at least a serious stock market drawdown.
The concern is that investors may have more exposure to the AI trade than they realize, according to Amy Wu Silverman, RBC Capital Markets’ head of derivatives strategy. That’s all well and good when the market is up, but it could leave investors vulnerable if the AI bubble bursts.
“It’s the surge protector plugged into itself,” Silverman said about the market’s AI exposure on Yahoo Finance’s Market Hang on Tuesday, referring to a meme about the illusion of infinite power.
Read more: How to protect your portfolio from an AI bubble
Silverman explained that because artificial intelligence touches so many industries, it has distorted typical stock market signals.
One example is market correlation, which gauges how closely stocks or other assets move in relation to each other. When there’s low correlation, one asset type zigs while the other zags, offering investors ample room to diversify their trades and protect from downside risk.
CBOE’s three-month implied correlation index, which approximates the market’s expectations for how correlated stocks will be over the next three months, is currently trading near its lowest level this year.
However, that metric may be misleading in current markets, Silverman pointed out, as the AI infrastructure build-out and demand for compute have broadened the AI theme to non-tech sectors.
“I always think of things from a risk perspective,” Silverman said. “We’re in a highly dispersed market, meaning correlation in the S&P 500 is very low, but that’s not true, right? Because it’s actually all the same trade. Your utilities trade, your energy trade, your politics, your capex. What does it come back to? One thing: that AI needs to do the spend to keep going, and it’s everywhere.”
“So it’s actually a very correlated risk that’s not being reflected in the correlation levels themselves,” Silverman added.
The AI-driven market doesn’t appear to be slowing, either, meaning events like the midterm elections or even low-probability market shocks could have drastic cascading effects.
“I think this P(doom) [the probability of a doomsday scenario] … is actually much higher than the market has priced,” Silverman said. “The market’s essentially saying 0.5% risk of all these circular financing fees, these downside, these left tails, and I have thought for a while now that that probability is substantially higher.”
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