Analysts Warn AI Stock Bubble Could Burst as Treasury Yields Near 5%
Capital Economics forecasts the S&P 500 will end 2026 at 8,250 before plunging 21% to 6,500 by the end of 2027, citing late-stage bubble indicators. Rockefeller International's Ruchir Sharma warns a 10-year Treasury yield above 5% could trigger the AI boom's unraveling.
Investors may still have a few months of gains left in the AI-driven stock market boom, but analysts are warning that the rally is showing the hallmarks of a late-stage bubble that could burst as soon as next year. Capital Economics senior markets economist James Reilly reiterated a forecast that the S&P 500 will end 2026 at 8,250, up 7.7% from Friday's close, before plunging 21% to 6,500 by the end of 2027.
«On balance, we think the data look consistent with a late-stage bubble,» Reilly wrote in a note on Thursday. «Most of the factors we consider are at, or close to, levels that have preceded past stock market peaks.»
Reilly pointed to several indicators he has been tracking that suggest the market is nearing a top. Stock valuations are consistent with a late-stage bubble, with the market's cyclically adjusted price-to-earnings ratio close to its dotcom peak and the S&P 500's valuation relative to Treasury bonds near dotcom extremes. Expected earnings growth also looks unsustainable, as forward 12-month earnings-per-share growth for the S&P 500 is in line with the peak of the dotcom bubble.
The sustainability of AI investment is increasingly in doubt amid massive spending and shrinking free cash flow. The combined free cash flow for the top AI hyperscalers is expected to turn negative in 2027. Market-cap concentration in fewer stocks is at extreme levels, a narrowness often associated with unsustainable rallies. Equity issuance is also booming, and given the pipeline of initial public offerings and follow-on offerings, another gusher of stocks is on the way. In the past, such activity has signaled a bubble's end was just months away, not years.
Reilly did not mention the recent surge in Treasury yields, with the 10-year rate hitting 4.97% on Friday. But for Rockefeller International Chairman Ruchir Sharma, it is another major bubble-busting indicator to watch. In a recent Financial Times op-ed, Sharma warned the AI bubble could pop when the 10-year yield «decisively breaches» 5%, which has been 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,» Sharma wrote. Borrowing costs that high would hit the AI boom in several ways. Hyperscalers would likely issue fewer bonds to finance their spending, and they would have more trouble issuing new equity, as yields above 5% have historically been a headwind for stocks. In addition, yields topping 5% would start to approach nominal GDP growth, making the national debt even more unsustainable.
While some on Wall Street have argued that yields are merely normalizing after years of being suppressed by central bank policies, Sharma noted the U.S. is much more addicted to debt now, with the burden 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 staunch bulls are growing more anxious. Wall Street veteran Ed Yardeni lowered the odds of his «Roaring 2020s» stock market scenario for the rest of the decade from 80% to 70% and raised the odds of a bearish outcome from 20% to 30%. «Admittedly, recent developments in the oil and bond markets are unnerving,» Yardeni said in a note on Saturday.
The warnings come as investors weigh whether the AI-fueled rally can continue or whether it is approaching the kind of speculative excess that preceded past market crashes. With valuations stretched, earnings growth expectations elevated, and Treasury yields creeping toward a critical threshold, the coming months could prove decisive for the trajectory of U.S. equities.
