The AI-led stock market boom may be approaching its final stages, with one analyst forecasting further gains before a sharp fall in US equities by the end of 2027.
James Reilly, senior markets economist at Capital Economics, expects the S&P 500 to reach 8,250 by the end of this year, 7.7% above Friday’s close. He then predicts a 21% decline to 6,500 by the end of 2027.
“On balance, we think the data look consistent with a late-stage bubble,” Mr Reilly wrote in a note. “Most of the factors we consider are at, or close to, levels that have preceded past stock market peaks.”
His concerns include market valuations, expected earnings growth, heavy concentration in a small number of shares and a surge in new equity issuance.
The cyclically adjusted price-to-earnings ratio is close to its level at the height of the dotcom boom, while the S&P 500’s valuation relative to Treasury bonds is also near dotcom-era extremes. Forward 12-month earnings-per-share growth is at a similar level to that seen at the peak of that bubble.
Mr Reilly also questioned whether the huge investment in artificial intelligence can be sustained. Combined free cash flow among the leading AI hyperscalers is expected to turn negative in 2027, according to the analysis.
The concentration of market capitalisation in a small group of companies has reached extreme levels, a pattern often associated with rallies that cannot continue indefinitely. A large pipeline of initial public offerings and follow-on share sales could add to the supply of equities, with previous surges in issuance occurring months rather than years before the end of a bubble.
Treasury yields add to AI market concerns
The 10-year Treasury yield reached 4.97% on Friday, a move identified by Ruchir Sharma, chairman of Rockefeller International, as another potential threat to the AI rally.
In a recent opinion article, Mr Sharma warned that the bubble could burst if the yield “decisively breaches” 5%, a level that has marked the upper end of its range since the dotcom era.
“This breach would signal the start of a new era of tighter money, in which AI mega projects will be harder to fund,” he wrote.
Higher borrowing costs could discourage hyperscalers from issuing bonds to finance their spending and make it harder for them to raise money through new shares. Yields above 5% have historically acted as a headwind for equities, according to Mr Sharma.
He also said yields at that level would begin to approach nominal economic growth, increasing pressure on US government debt. Although some on Wall Street view the rise in yields as a return to more normal conditions after years of central bank suppression, Mr Sharma said the US was more dependent on borrowing, with debt exceeding 100% of GDP.
“As a result, debt-servicing costs are much higher now,” he wrote. “Rising public borrowing costs will squeeze other borrowers sooner, and hit the bubbly AI markets harder.”
Even some prominent market optimists have become more cautious. Ed Yardeni, a Wall Street veteran, has cut the probability of his “Roaring 2020s” scenario for the rest of the decade from 80% to 70%, while raising the likelihood of a bearish outcome from 20% to 30%.
“Admittedly, recent developments in the oil and bond markets are unnerving,” Mr Yardeni said in a note.
