Firm that correctly called the AI rally slowdown says here’s where to hide out
The artificial intelligence trade may or may not be in a bubble, but no matter what happens there are still defensive areas to hide in if the market bursts, according to Capital Economics. James Reilly, Capital Economics senior markets economist, correctly called out a bearish view on the AI trade in early September, saying in a research report that the “AI equity boom is nearing an end.” Now the firm thinks that traditional defensive sectors in the stock market, including real estate and consumer staples “remain the best bet” to serve as sanctuaries in the event the AI momentum trade falters, Capital Economics said in a research note Thursday. In its latest analysis, Capital Economics forecasts that the S & P 500 will eventually fall to 6,500 by the end of 2027 if air continues to slowly leak out of the AI trade, or if the AI bubble bursts. That would equal a 16% decline. Final rally Before the reckoning, however, “a final rally in the stock market, led by tech stocks, is on the cards this year,” according to the firm. But “over the next 12 months defensive sectors may be the place to hide.” If the AI boom turns to bust, Capital Economics views U.S. Treasurys yields as a vital counterbalance. The firm expects Treasury yields to drop, pushing bond prices higher, saying the 10-year yield fell all eight times since 1995 when the PHLX Semiconductor Sector Index ( SOX ) index dropped 35% or more. If yields were to fall, real estate would benefit, Capital Economics said. “In contrast to energy and financials, it has tended to fare much better when SOX selloffs have coincided with falling yields,” the firm noted. But even there, real estate “would still fall,” albeit less than the market. An even better defensive sector to “ride out the AI bust” is consumer staples, Capital Economics said. “That sector made good gains after the peak in tech stocks in early 2000.” Under pressure The trade to capitalize on AI has been under pressure lately from investor concern that megacap tech companies like Meta Platforms , Microsoft , Amazon and Alphabet are spending billions in capital on AI infrastructure like data centers and chips without seeing an adequate return on their investments. Elevated capital expenditures have been eating into hyperscalers’ cash flows and profits. Alphabet reported disappointing earnings late Wednesday that showed negative free cash flow in the third quarter. Facebook and Instagram parent Meta reported negative free cash flow in its latest earnings last week, while raising the bottom end of its full-year capital expenditure commitment. Unlike past tech selloffs, Capital Economics called out energy and financials as areas that are unlikely to hold up as well this time. For one thing, both groups “have done much better” now than they did in earlier periods before technology sold off. “But this isn’t because these sectors are particularly well insulated from AI,” Capital Economics said. “Instead, it is because repeated supply shocks, especially for energy commodities, over recent years have lifted energy prices and, relatedly, Treasury yields.”
