Strategists warn of AI bubble as S&P 500 bifurcation deepens

Investment strategists Jim Paulsen and Michael Burry have issued stark warnings regarding a potential stock market bubble driven by artificial intelligence, highlighting a dangerous divergence between 'new era' AI stocks and traditional 'old era' companies. Paulsen, formerly the chief investment strategist for the Leuthold Group, described an "extreme" bifurcation in the S&P 500, noting that AI shares are racing ahead in isolation while many other companies are "essentially failing." This pattern, where the market awards failure alongside success, is historically associated with unsustainable rallies and subsequent downturns.

Data indicates that since March 30, 2026, new era AI stocks have performed nearly seven times better than the rest of the S&P 500 index, rising 36.2% compared to a 5.3% gain for the broader index. The disparity became particularly pronounced in mid-May 2026, when 5% of S&P 500 components reached 52-week lows while the overall index hit a record high. This phenomenon has been recorded only four times in history, underscoring the fragility of the current market structure.

Paulsen pointed to a drop in the correlation between new and old era stock price movements as a key risk indicator. He noted that for the last 30 years, the correlation of daily price movements has served as a reliable gauge for new era investors. The recent explosive rally in AI shares has been accompanied by an alarming drop in this trailing 12-month correlation, suggesting the contemporary rally may not be sustainable.

Michael Burry has criticised the AI sector for what he terms "supply-side gluttony," arguing that infrastructure is being overbuilt in response to hype rather than end-user demand. Burry wrote on his Substack that stocks are rising based on a "two-letter thesis" rather than jobs or consumer sentiment, drawing parallels to the period preceding the dot-com bubble burst. Other financial figures, including JPMorgan Chase CEO Jamie Dimon and Mad Money host Jim Cramer, have also expressed concerns about the sustainability of the current rally.

The divergence between new and old era stocks began in 2022 but has intensified recently. Some AI stocks are outperforming major tech giants such as Apple, Amazon, and Alphabet, despite some of these AI firms never having turned a profit. As the imbalance grows, investors are being urged to consider concentration risks and the potential for a notable pause or meaningful underperformance in the stocks that have been driving the market higher.