stock market
Some analysts expect the S&P500 to crash by 60%.

Artificial Intelligence (AI) is not just a buzzword, it's a game-changer in the stock market. From automating complex and redundant processes to solving long-standing industry challenges, AI is revolutionizing the way we trade. With the launch of ChatGPT and other natural language processing (NLP) chatbots and AI's use in autonomous driving, the tech is becoming faster and more accurate by the day when solving real-life problems.

While the impact of AI on the stock market is undeniable, concerns have remained. However, tech giants like NVIDIA, Microsoft, and Meta continue to shape the industry, and the stock prices of top AI companies have ballooned since early 2023, taking their valuations to record levels quickly.

However, it's not all smooth sailing. In a report, the research firm Capital Economics projected stock price corrections in 2026 due to high interest rates and elevated inflation. The firm stated that the AI-driven stock market bubble, due to rising investor interest in the technology, will burst in 2026. This presents both risks and opportunities for investors, as the S&P 500 index will reach a record-high of 6,500 next year before inflated stock valuations begin to unwind.

"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 late 1990s and early 2000s dot-com bubble and the Great Crash of 1929," said economists at Capital Economics, Diana Iovanel and James Reilly.

It's important to note that several analysts hold diverging views on AI and the idea of a stock market bubble. Bank of America (BofA), for instance, expects the index rally to continue. BofA's technical strategist Stephen Suttmeier sees the S&P 500 rising 34% from current levels to 7,000 by the end of 2026. This contrasting viewpoint adds depth to the analysis and provides a comprehensive understanding of the current market situation.

"The SPX has rallied 46% from its October 2022 low...The median rally from a big low of 106% lasts approximately four years, suggesting that SPX 7000 is not ruled out into late 2026," Suttmeier said. "The secular bull markets from 1950-1966 and 1980-2000 lasted 16 and 20 years, respectively, which means that the current secular bull market is middle-aged and can extend until 2029 to 2033."

Elsewhere, B.Riley Wealth Management chief investment strategist Paul Dietrich also estimated the S&P 500 index could fall by up to 49% in the next recession, given its current overvaluation. Furthermore, veteran advisor Milton Berg, who also runs Milton Berg Advisor, opined in March that analysts forecasting a 60% decline in the S&P 500 index might be proven correct as market speculations reach dangerous levels.

Many are right to think that AI will boost productivity and introduce transparency, but the subsequent economic growth may lead to higher inflation. The stock market sell-off in March coincided with the high consumer inflation report and the diminishing hopes of the previously expected rate cuts this year by the US Federal Reserve. Markets are now adjusting to a single or two rate cuts in the remainder of 2024.

"Ultimately, we anticipate that returns from equities over the next decade will be poorer than the previous one. And we think that the long-running outperformance of the US stock market may end," said Iovanel and Reilly. "American exceptionalism may end in the coming years."

While a bubble burst is a possibility, resulting in a decade of investment returns favouring bonds over stocks, there are also potential opportunities for investors. The economists anticipate stronger returns as government bond yields settle at higher levels. This insight equips investors with the knowledge to make informed decisions and navigate the market effectively.

The firm projected that in the decade from 2024-33, average yearly returns from US stocks will stand at 4.3% while the US 10-year Treasury yield could inch higher to 4.5%. Remember, US stock returns averaged 13.1% in the past decade, while long-term annual returns were nearly 7% after inflation.

"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," the economists noted.

While sovereign bond yields are expected to notch higher as stock valuations face downward pressure, Capital Economics believes equities will benefit from AI adoption in most industries and higher corporate earnings.

Disclaimer: Our digital media content is for informational purposes only and not investment advice. Please conduct your own analysis or seek professional advice before investing. Remember, investments are subject to market risks and past performance doesn't indicate future returns.