Capital Economics Sees AI Stock Bubble Nearing Peak

Bubble indicators flash warning on AI rally

A Wall Street research firm that has been consistently bullish on artificial intelligence stocks now says the boom is approaching its end. Capital Economics, which has maintained above-consensus forecasts for the S&P 500 since mid-2023, is warning that multiple market indicators point to a bubble nearing its peak.

Senior market economist James Reilly tracks eight distinct measures to identify late-stage market bubbles, including valuations, earnings expectations, index concentration, equity issuance, and foreign investment flows. Several of these metrics have reached or exceeded levels last seen before major market peaks, according to analysis published Thursday.

Earnings expectations reach dot-com extremes

The most alarming signal comes from earnings forecasts. Current expectations for S&P 500 earnings growth match levels seen only at the height of the dot-com bubble, while long-term earnings-per-share projections have climbed to record highs. Because this anticipated growth is heavily concentrated in technology companies, any disappointment from major tech firms would disproportionately impact the broader index.

Index concentration itself has reached dot-com-era extremes, with market gains driven by a narrow group of large-cap technology stocks. Net equity issuance has turned positive, and foreign ownership of U.S. equities stands at all-time highs. Reilly notes that previous waves of initial public offerings and secondary share sales have historically coincided with market peaks, suggesting "the end of the bubble is just months away, rather than years."

Why it matters

This assessment carries particular weight because Capital Economics has been more optimistic than most Wall Street firms on AI's transformative potential. The firm's shift from bullish to cautious—while maintaining its view that AI represents genuine technological progress—suggests the concern is about valuation and timing rather than the underlying technology. For corporate technology leaders, this signals a potential window to secure funding or complete strategic transactions before market conditions deteriorate.

Mixed signals on leverage and volatility

Not all indicators are flashing red. Measures of market leverage, while moving in a "concerning direction," haven't reached the extreme levels seen in previous bubbles. Volatility metrics appear consistent with a mid-stage rather than late-stage bubble, and stock-level volatility remains below the extremes observed near the end of the dot-com boom.

Despite the warning signs, Capital Economics maintains a near-term bullish stance. The firm forecasts the S&P 500 will climb from approximately 7,650 to 8,250 by year-end 2026—an 8% gain. However, the projection calls for a sharp reversal in 2027, with the index falling to 6,500, representing a 21% decline from the anticipated peak.

The details were first reported by CNBC.