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Capital Economics says the S&P 500 will rise next year and then face a double-digit correction.
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The research firm said it expected the index to rise to 8,000 points before falling back to 7,000 points.
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The company said this is because investors will realize that technology stocks have become overvalued.
Stocks will have one last hurray next year before the artificial intelligence-fueled rally collapses, a research firm says.
Capital Economics said in a recent client note that it believes the S&P 500 could rise next year before experiencing a sharp correction. The company wrote on Monday that it expects the benchmark index to rise to 8,000 points in 2026 and fall to 7,000 points next year, a decline of about 13% to “more normal levels.”
“A more likely scenario is that the stock market ‘collapses under its own weight’ as investors reassess the valuations of big tech companies while still believing in the long-term benefits of AI to the real economy,” wrote Jennifer McKeown and William Jackson, two of the firm’s economists. They added that in the worst-case scenario, a 30% correction is possible.
The company believes double-digit declines are brewing for several reasons:
Valuations are high, but not excessive, given the strength of corporate earnings. However, Thomas Mathews, the firm’s head of markets, wrote on Monday that tech stocks are expensive and may continue to rise.
Matthews pointed to the U.S. technology sector’s 12-month price-to-earnings ratio, a measure of stock valuations. The ratio briefly rose to its highest level since the dot-com bubble last year before falling back, according to analysis by Capital Economics.
“We suspect that rising valuations are more likely as the rally progresses. Indeed, while we believe valuations are not yet overstretched, it would not be surprising if investor enthusiasm for AI technology pushes valuations above long-term sustainable levels,” Matthews said.
While the earnings backdrop remains positive, the S&P 500’s earnings growth has been largely concentrated in the technology sector, a key weakness in valuations.
“It’s true that earnings expectations rather than valuations may be a ‘bubble,'” Matthews speculated.
He added: “It’s also possible that the rapid growth in tech earnings will eventually return to normal, although that doesn’t appear to be happening this year.”
Mathews said the AI rally could also be hurt if the U.S. economy begins to slow significantly, though he noted that economic growth currently looks healthy and the risk of a recession looks “minimal.”
There is also a risk that AI may not deliver what investors initially expected, or that China may start to move ahead of the U.S. on the technological frontier.
Matthews pointed to lingering concerns about artificial intelligence capital spending, a key issue plaguing the market and triggering multiple sell-offs over the past year.
Concerns about Chinese AI innovations such as DeepSeek also triggered a sharp sell-off in early 2025.
Matthews said of the threat from China that “on the face of it, it’s a huge threat to big U.S. tech companies,” though he pointed to factors such as the “hardware advantage” U.S. companies have that could protect the tech industry.
This year, markets have gotten a taste of how geopolitical tensions can dampen enthusiasm for artificial intelligence. The company noted that recent market volatility stems from President Donald Trump’s threats to Greenland.
The report added that geopolitical conflicts could have a more significant impact on AI trade, given that Europe is a major market for the U.S. technology industry. According to analysis by Capital Economics, U.S. allies and partners in Europe account for about 40% of technology company revenue.
“But our sense is that for the AI rebound to have a lasting impact, they must either have a significant impact on the U.S. economy or have a significant impact on tech company earnings through other channels,” Matthew added.
Read the original article on Business Insider