Capital Economics warns that the artificial intelligence-driven stock market bubble could burst in 2026.
The research firm said a stock market bubble fueled by investor excitement about artificial intelligence will push the S&P 500 to a high of 6,500 by 2025. Technology stocks will lead the gains.
But starting in 2026, stock market gains should fall back sharply as rising interest rates and inflation begin to drive down stock valuations.
Diana Iovanel and James Reilly, economists at Capital Economics, said: Ultimately, we expect stock returns to be lower over the next decade than the previous decade.
We believe the long-running outperformance of U.S. stocks may be coming to an end.
The two economists believe that the increasing popularity of artificial intelligence will drive economic growth driven by productivity improvements.
This economic stimulus should lead to higher inflation than most expect. It will also lead to higher interest rates.
Higher interest rates and inflation are ultimately bad news for stock prices. As evidenced by the recent decline in stocks, which was triggered by the surprise CPI inflation report in March.
The two economists said: We suspect that the bubble will eventually burst after the end of next year, causing a correction in valuations.
After all. This dynamic was present during the dot-com bubble of the late 1990s and early 2000s and the Great Crash of 1929.
The expected bursting of the stock market bubble will tilt investment returns toward bonds rather than stocks over the next decade.
Capital Economics said of the fixed income market: With government bond yields stabilizing at higher levels, we expect returns to be higher.
Capital Economics predicts that from now to the end of 2033, the average annual return on the U.S. stock market will be only 4.3%. Far lower than the long-term average return of about 7% after excluding inflation factors.
At the same time, Capital Economics said it expects the return on U.S. Treasury bonds to reach 4.5% over the same period, slightly higher than the stock market\’s gain.
These expected returns contrast sharply with the 13.1% average annual return for U.S. stocks over the past decade.
American exceptionalism may be over in the next few years, Ivanel and Reilly say.
However, the two economists believe that there is a major risk to their outlook: accurately timing the peak of the stock market bubble and how long the bubble burst may last. This is difficult in itself.
When and how the AI-driven stock market bubble bursts is a key risk in our forecast.
In particular, one downside risk is that the aftermath of a bubble burst lasts longer than a year, as was the case after the dot-com bubble, say Ivanel and Reilly.
Capital Economics warns: AI bubble will burst in 2026
Capital Economics warns that AI-fueled stock market bubble could burst in 2026
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