Economists are sounding alarms about potential market turmoil if the artificial intelligence boom follows a similar trajectory to the dot-com bubble of the late 1990s, though the worst-case scenario might be delayed until late 2026.
Dot-Com Parallels and Projected Declines
The extraordinary rise of artificial intelligence has drawn frequent comparisons to the internet stock frenzy that characterized the dot-com era. The painful unwinding of that technology-driven rally 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 devastating declines of 82% and 74% respectively.
Recent selloffs in the tech sector have raised concerns that the AI rally might be approaching its end, but Capital Economics remains cautiously optimistic about the short-term outlook. The firm believes the AI bubble has approximately another year to inflate before potentially bursting.
Capital Economics' Market Forecast
According to John Higgins, Capital's chief markets economist, if the current rally continues and the S&P 500 reaches 8,000 by the end of 2026 as the firm predicts, subsequent corrections could include drops of at least 30% in the index and 60% in big-tech sectors combined.
Higgins provides crucial context for these projections, noting that without the AI boom, the S&P 500 would be 25% lower today even before accounting for the additional gains Capital anticipates through 2026.
The correction envisioned by Capital would be slightly smaller and significantly shorter than the dot-com meltdown, with one critical difference: the absence of an accompanying recession. The 2001 recession followed the market crash and was largely triggered by Federal Reserve interest rate hikes.
Divergence from Historical Precedent
The current economic environment differs substantially from the dot-com era in several key aspects. Between 1995 and its peak in March 2000, the Nasdaq rose 400% during the internet stock frenzy. Concerned about inflation, the Fed began raising rates in 1999 and increased them by 1.5 percentage points in less than a year.
This time, Capital Economics expects the Federal Reserve will likely cut rather than raise rates and does not anticipate a recession accompanying any market correction.
While defensive sectors such as consumer staples should weather the storm relatively well, utilities—which have benefited from the massive power demands of AI data centers—may face significant challenges during a downturn.
Potential Silver Linings and Recovery Patterns
There are potential bright spots in this scenario. As the S&P 500 becomes less concentrated on technology, other stocks could climb higher, mirroring the pattern that emerged after the dot-com crash.
Historical data suggests that big tech sectors typically recover within five years after a major crash, though they may not regain their former dominance over other cyclical stocks. Higgins notes that something similar might happen again as AI-driven productivity gains begin to manifest across broader segments of the economy.
Capital acknowledges that the rally may still have room to run, pointing to recent tech stock gains following last week's selloff. However, the economists added a note of caution: given the recent pullback in the stock market, it isn't out of the question that the bubble is starting to burst now.
