AI-Fueled Stock Market Bubble Predicted to Burst in 2026, Says Capital Economics

A Research firm, Capital Economics, predicts an artificial intelligence-driven stock market bubble will burst in 2026. The research firm anticipates that investor enthusiasm for artificial intelligence will propel the S&P 500 to a peak of 6,500 by 2025, with technology stocks leading the charge. However, starting in 2026, these gains are expected to reverse sharply as higher interest rates and elevated inflation weigh down equity valuations. 

Some market economists at Capital Economics commented on the data:

Ultimately, we anticipate that returns from equities over the next decade will be poorer than over the previous one. And we think that the long-running outperformance of the US stock market may come to an end.

Capital Economics’ Diana Iovanel and James Reilly

Bonds to Outperform Stocks

Their bearish outlook is somewhat counter-intuitive since they also expect the adoption of AI to boost economic growth through increased productivity. This economic boost is predicted to lead to higher-than-expected inflation and, consequently, higher interest rates. Historically, higher interest rates and inflation are bad news for stock prices, as shown by the recent market decline triggered by a hot March CPI inflation report.

“We suspect that the bubble will ultimately burst beyond the end of next year, causing a correction in valuations. After all, this dynamic played out around both the dot-com bubble of the late 1990s and early 2000s and the Great Crash of 1929,” Iovanel and Reilly explained.

The anticipated bursting of the stock market bubble should usher in a decade where investment returns favor bonds over stocks. “We expect stronger returns as government bond yields settle at higher levels,” Capital Economics stated regarding the fixed-income market. 

Historical Parallels and Risks

From now until the end of 2033, Capital Economics forecasts average annual returns of just 4.3% for US stocks, significantly below the long-term average return of about 7% after inflation. In contrast, they expect US Treasurys to return 4.5% annually, slightly outpacing equity gains. This starkly contrasts with US stocks’ 13.1% average annual returns over the past decade.

“American exceptionalism may end in the coming years,” Iovanel and Reilly remarked. However, a significant risk to their outlook is the inherent difficulty in accurately timing the peak of a stock market bubble and the duration of its unwinding. “When and how the AI-fueled equity bubble bursts is a key risk to our forecast. In particular, one downside risk is that the aftermath of the bubble bursting lasts longer than one year, as was the case following the dot-com bubble,” they concluded.