AI Bubble Collapse Could Spark 30% Stock Plunge, Capital Economics Warns

A bursting of the artificial intelligence bubble could trigger a steep decline in global equity markets, a modest rally in sovereign bonds, and a weaker U.S. dollar, according to a new analysis from Capital Economics.

The Epicenter of a Potential Crash

In a note published Monday, Capital Economics' chief economic adviser, John Higgins, warned there are "plenty of signs that we are now in the late stages of a bubble in AI." The firm believes the U.S. stock market would be at the center of any potential fallout from such an event.

Comparing the current environment to the dot-com bubble, Higgins stated that the eventual peak-to-trough decline in the S&P 500 could be at least 30%. According to the note, a drop of this magnitude has only occurred seven times in the past century. The firm's end-2027 forecast for the S&P 500 is 6,500, which is approximately 21% below its projection of 8,250 for the end of 2026.

A Multi-Asset Fallout

While the U.S. would likely bear the brunt of a correction, the report anticipates a contagious effect on global markets, though the impact would be smaller in regions that are less concentrated in technology stocks. Capital Economics outlined several potential market reactions:

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• Sovereign Bonds: A modest rally is expected, with yields on 10-year developed-market bonds forecast to edge lower by the end of 2027. However, the firm does not expect a repeat of the large Treasury rally seen after the dot-com bust, citing less scope for term premia to fall.
• Corporate Bonds: Some fallout is anticipated in the U.S. corporate bond market due to currently very low credit spreads, though the impact is expected to be smaller than what followed the dot-com crash.
• U.S. Dollar: The dollar is forecast to weaken, with Higgins noting that the currency is even more overvalued now than it was during the tech bubble of the late 1990s.

Echoes of the Dot-Com Era

The analysis frequently draws parallels to the bursting of the dot-com bubble as the most relevant historical precedent. However, the note highlights key differences in the current macroeconomic environment that would likely lead to different outcomes in fixed-income and currency markets.

The potential for a less pronounced rally in government bonds and a more significant decline in the dollar are key distinctions from the market reaction two decades ago. These forecasts underscore the unique conditions shaping investor sentiment and asset valuations in the current AI-focused market cycle.