- JPMorgan says technological innovation like big data and artificial intelligence could cause the next big market correction.
- The firm notes that financial conditions are overheating, which has already created a situation with little room for error.
Apparently too much technological advancement can be a bad thing ... at least in the early stages of a revolution.
That's according to JPMorgan, which says market cycles can sometimes become victims of their own progress.
As new ideas or techniques arise, that can create "huge volatility," which in turn pulls in new participants who aren't prepared or knowledgeable enough to immediately know what they're doing, JPMorgan says. The firm warns of the dire short-term consequences that can result and highlights two key areas of innovation that could lead to issues.
"This then leads to excesses and corrections before better management and expertise leads innovations to become incorporated in daily economic and financial life," Jan Loeys, the head of asset allocation and alternative investments at JPMorgan, wrote in a client note. "Today innovation is all about big data and AI (artificial intelligence), which will eventually greatly transform society, but could easily become the core of the next major correction."
But big data and AI alone won't be enough to end what's been a historically strong market, with stocks now in their ninth year of a bull market. Other stresses must be roiling the market, and JPMorgan sees that coming from what it describes as "financial overheating."
An example of this can be seen in a trade that involves shorting equity volatility, or betting against moves in the stock market. One of the most crowded trades around, many market experts have stressed caution over what they see as artificially suppressed price swings that could unfurl any day.
Of most concern for JPMorgan right now are lofty stock valuations, investment-grade bond spreads, and junk-bond yields. And the firm notes that once investors get one taste of success, they'll continue chasing returns, even as bubble conditions start to form.
"The speed of these upgrades and asset price rallies is both exhilarating and scary," Loeys wrote. "The faster we rally, the greater the joy, but the more one should be worried about the eventual reckoning."
So what does the firm think you should do? Start trimming positions or putting on hedges, even if the market looks invincible. If they're right about a coming correction, you'll be glad you did.