UK Stocks Positioned for Resilience if AI Bubble Bursts, Says Capital Economics

The UK stock market is uniquely positioned to hold up better than most of its peers if the current artificial intelligence-fueled equity rally ends, according to an analysis by Capital Economics. The research firm argues that the market's defensive composition and low exposure to the tech sector provide a buffer that was absent during the dot-com crash.

A Different Era for UK Equities

In a note to clients, Markets Economist Joe Maher highlighted key differences between the current market and the environment leading up to the dot-com crash in 2000. While the MSCI UK Index fell approximately 40% in dollar terms from its peak back then, not far behind the MSCI USA Index's 50% decline, the underlying structure of the UK market has since changed dramatically.

Capital Economics outlines three primary reasons for its optimistic outlook:

• Reduced Tech Exposure: Prior to the dot-com bust, the Information Technology and Communication Services sectors comprised around 30% of the MSCI UK index. Today, that figure has fallen to just 3%. "Its minimal tech exposure and defensive make-up should put it in good stead," Maher stated.
• Resilient Economic Outlook: The 2000 crash was compounded by a U.S. recession in 2001. This time, the firm expects the U.S. economy to remain resilient, which should help "limit the drawdown in global equity markets," including the UK.
• Expected Dollar Weakness: Should the AI boom falter, Capital Economics anticipates the Federal Reserve would shift toward monetary easing, weakening the U.S. dollar. This could provide a relative boost to sterling-denominated assets.

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Market Context and Performance

The analysis comes as tech stocks have recently seen a selloff. Year-to-date, the UK's FTSE 100 is up 9.21%, while the tech-heavy Nasdaq 100 has gained 12.17% but has fallen 3.6% over the past month. The FTSE 100, by contrast, is up around 2% in the same monthly period.

Capital Economics noted that it has been forecasting the AI bubble will burst within the next year, suggesting that "it’s possible that this process is already underway." The firm also cautioned that the recent outperformance of UK energy and financial stocks, driven by geopolitical tensions and market volatility, may be temporary.