Economists are sounding alarms about potential market turmoil if the current artificial intelligence boom follows a similar trajectory to the dot-com bubble of the late 1990s. Recent selloffs in the technology sector have raised concerns that the AI rally might be approaching its end, though one prominent research firm believes there's still time before the bubble bursts.
Dot-Com Comparisons and Potential Fallout
The extraordinary rise of artificial intelligence has drawn frequent comparisons to the technology-driven rally of the late 1990s. The painful unwinding of that bubble saw the S&P 500 fall 49% from its peak in March 2000 to its trough in October 2002. During that same period, information technology and communication services sectors experienced even more dramatic declines of 82% and 74% respectively.
Capital Economics chief markets economist John Higgins predicts that if the current AI rally continues and pushes the S&P 500 to 8,000 by the end of 2026 as his firm forecasts, subsequent corrections could see the index drop by at least 30% while big-tech sectors combined could plummet by 60%.
Key Differences From Previous Tech Bubble
Despite the concerning parallels, there are significant differences between the current situation and the dot-com era. The Nasdaq rose 400% between 1995 and its peak in March 2000 during the internet stock frenzy. That bubble was largely popped by Federal Reserve interest rate hikes, which saw increases of 1.5 percentage points in less than a year starting in 1999.
This time around, the economic environment appears more favorable. Capital Economics does not expect a recession to accompany any potential market correction, and the Federal Reserve is more likely to cut rather than raise interest rates in the coming period.
Sector Impacts and Long-Term Outlook
The collateral damage from an AI bubble burst would be unevenly distributed across market sectors. Defensive sectors such as consumer staples would likely hold up relatively well, while utilities - which have recently been boosted by the enormous power demands of AI data centers - would fare less favorably in a downturn.
On a positive note, as the S&P 500 becomes less concentrated on technology stocks, other sectors could climb higher, similar to what occurred after the dot-com crash. Historical patterns suggest that while big tech sectors typically recover within five years after a major crash, they often don't retain their former dominance over other cyclical stocks.
Capital Economics notes that the S&P 500 would be 25% lower today without the AI boom, not counting the additional gains the firm predicts through 2026. The envisioned correction would be slightly smaller and significantly shorter than the dot-com meltdown.
While the research firm believes the AI rally has another year to run, they caution that given recent pullbacks in the stock market, it isn't out of the question that the bubble is starting to burst now. Technology stocks were leading gains again after last week's selloff, suggesting the AI story still has momentum, but investors should remain vigilant about potential risks.
