European Central Bank warns that concentration in highly-valued U.S. tech stocks poses financial stability risk

MW European Central Bank warns that concentration in highly-valued U.S. tech stocks poses financial stability risk

By Jamie Chisholm

High equity valuations and investors' concentration in big U.S. technology stocks are among the main risks to financial stability, according to the European Central Bank.

In its November Financial Stability Review the eurozone monetary guardian noted that markets have proved resilient of late with episodes of volatility proving brief and having only a limited impact on the broader financial system.

"However, underlying financial market vulnerabilities - notably stretched valuations and risk concentration - remain significant, making further bouts of volatility more likely than usual," the ECB said.

Record low equity risk premia - the excess return that investing in the stock market provides over a risk-free rate - and compressed corporate bond spreads on both sides of the Atlantic suggest that investors are underpricing the chances of "adverse scenarios," said the ECB.

It also noted in its biannual report that the concentration of equity market capitalization and earnings among a handful of companies, notably in the U.S, has increased greatly in recent years.

For example the Magnificent 7 comprising Alphabet $(GOOGL)$, Amazon.com $(AMZN)$, Apple $(AAPL)$, Meta Platforms $(META)$, Microsoft $(MSFT)$, Nvidia $(NVDA)$ and Tesla $(TSLA)$ command about 33% of S&P 500 SPX valuation, according to MarketWatch calculations.

"This concentration among a few large firms raises concerns over the possibility of an AI-related asset price bubble. Also, in a context of deeply integrated global equity markets, it points to the risk of adverse global spillovers, should earnings expectations for these firms be disappointed," said the ECB.

The high valuations and low risk premia leaves the market highly vulnerable to a shift in risk appetite, which could be sparked by a number of factors, such as weakening growth prospects, an unexpected uptick in inflation, a further escalation in geopolitical tensions or disappointing corporate earnings, according to the ECB.

A recent report from the U.S. Office of Financial Research displayed similar anxiety, noting that for the first nine months of 2024 the Magnificent 7 minus Tesla accounted for 45% of the S&P 500's return of 21%. "If the prices of those stocks are based on unrealistic expectations about profits associated with AI, the S&P 500 could fall sharply," said the OFR.

Other areas of financial risk that the 20th anniversary FSR noted were Europe corporate bond spreads, where "market pricing appears benign despite elevated macroeconomic uncertainty", and the heightened policy and geopolitical uncertainty which is "exacerbating sovereign [debt] vulnerabilities".

The ECB also expressed concern at what it called "concentrated exposures, liquidity mismatches and high leverage" in parts of the non-bank financial intermediation (NBFI) sector, where market shocks could deliver margin calls on derivative exposures.

-Jamie Chisholm

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November 20, 2024 10:34 ET (15:34 GMT)

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