Capital Economics has warned that the artificial intelligence-driven stock market rally is showing signs of excessive optimism and may be approaching its final stage, even as the firm expects continued near-term upside.
The research firm projects the S&P 500 will reach 8,250 by the end of 2026 before retreating to approximately 6,500 by the end of 2027, reflecting a significant pullback in valuations.
Valuation Concerns
Capital Economics' caution centers on valuation metrics that have climbed sharply since the artificial intelligence boom began in early 2023. The cyclically adjusted price-to-earnings (CAPE) ratio has risen more than 12 points during that period and now stands above 40, a level last seen before the dot-com bubble collapse.
According to the analysis, valuation expansion has been responsible for most of the S&P 500's gains over the past three years. While traditional forward price-to-earnings metrics appear less stretched, longer-term valuation measures present a more concerning picture.
Concentration and Structural Risks
The warning comes as a small group of technology and semiconductor companies continues to account for a significant share of market advances, increasing concentration risk across U.S. equities. Capital Economics noted that the concentration of market value in a narrow group of artificial intelligence beneficiaries now exceeds the technology sector's weighting during the late-1990s bubble peak.
The firm also questioned whether the exceptional earnings growth supporting artificial intelligence stocks can continue indefinitely, highlighting rising technology-related capital spending relative to economic output and a near-record ratio of stock market value to corporate net worth as additional signs of market overheating.
Potential Triggers for Correction
Although Capital Economics is not predicting an immediate downturn, it warned that weaker-than-expected revenue growth or a reassessment of artificial intelligence spending assumptions could quickly undermine investor sentiment.
The analysts previously estimated that if the S&P 500 reaches around 8,000 by the end of 2026, a subsequent decline of at least 30 percent could become increasingly likely. Capital Economics also pointed to other factors that could amplify downside risks, including strong foreign inflows into U.S. equities and a potential increase in share supply through major initial public offerings and secondary stock sales by large technology companies.
