Capital Economics has warned that the recent decline in artificial intelligence-related stocks could continue, as analysts’ earnings expectations for technology companies have yet to reflect growing concerns about the outlook for AI investment.
In a research note published this week, the economic research firm highlighted a divergence between falling technology share prices and continued increases in corporate profit forecasts.
“The AI correction in equities could have much further to run,” Capital Economics wrote.
The firm suggested that earnings estimates may eventually face downward revisions if investor sentiment continues to deteriorate or major technology companies begin reducing their planned expenditure on AI infrastructure.
Technology Earnings Forecasts Continue to Rise
Capital Economics noted that analysts have continued raising profit expectations for companies benefiting from artificial intelligence investment, despite the recent weakness in their share prices.
The firm attributed part of this divergence to the spending commitments made by hyperscalers, the large cloud computing companies responsible for substantial investment in AI infrastructure.
Rather than reducing their expenditure plans, these businesses have continued to increase their commitments to computing capacity and related infrastructure.
This spending has supported expectations for revenue and earnings growth among companies supplying AI processors, equipment and other technology.
However, Capital Economics cautioned that analyst forecasts can take time to respond to changing market conditions.
The firm believes current estimates may not fully reflect the possibility of weaker demand or a slowdown in AI-related investment.
Hyperscaler Spending Remains a Key Risk
Capital expenditure by major cloud computing companies has been an important factor supporting the rise in AI-related technology shares.
Capital Economics warned that any concrete indication of reduced spending commitments could lead investors to reassess expectations for companies benefiting from the AI investment cycle.
A slowdown in hyperscaler expenditure could affect demand for semiconductors, data centre equipment and other infrastructure associated with artificial intelligence.
The firm suggested that such developments could result in downward revisions to earnings forecasts that have continued to increase during the recent market decline.
For now, hyperscalers have maintained or expanded their investment plans, but Capital Economics considers the potential for future reductions an important risk to monitor.
European Equities Show Relative Resilience
European stock markets have performed comparatively well during the recent decline in AI-related equities.
Capital Economics noted that the MSCI Europe Index recorded a modest gain last week, despite weakness in technology shares elsewhere.
The firm acknowledged that a more substantial global equity sell-off could eventually affect European markets, as has occurred during previous periods of market stress.
However, it suggested that the current situation may differ because the earlier AI-driven rally was concentrated in a relatively small group of technology companies.
This concentration could mean that a further correction has a greater effect on markets with substantial exposure to AI-related stocks.
“We expect Europe to continue to outperform if the bubble deflates further,” Capital Economics said.
The forecast reflects the firm’s expectation of relative European market performance rather than an assumption that European equities would necessarily avoid losses.
US Treasury Bonds Could Benefit From Further Equity Weakness
Capital Economics also expects the recent rally in US Treasury securities to continue if equity markets experience additional declines.
The firm suggested that investors could increase their allocations to government bonds as they seek assets perceived as relatively safe during periods of market volatility.
Increased demand for Treasuries generally supports bond prices and places downward pressure on yields.
The research firm also identified a potential connection between AI investment plans and expectations for US monetary policy.
If hyperscalers begin reducing capital expenditure, investors could increase expectations for Federal Reserve interest rate cuts further into the future.
Such a shift in rate expectations could provide additional support for Treasury prices.
Capital Economics Expects Further Declines in Bond Yields
Capital Economics anticipates that US Treasury yields could continue declining as investors reassess the outlook for technology shares and economic activity.
“We expect yields to fall a bit further,” the firm wrote.
The forecast reflects two potential developments: increased demand for government bonds during equity market weakness and expectations of lower Federal Reserve interest rates if corporate investment slows.
The extent of any decline would depend on financial market conditions, economic data and changes in monetary policy expectations.
AI Investment Outlook Remains Central to Market Expectations
Capital Economics’ assessment highlights the potential disconnect between the recent performance of AI-related shares and analysts’ expectations for corporate earnings.
While major technology companies have continued expanding their AI investment commitments, the firm believes earnings forecasts could face pressure if sentiment deteriorates further.
Any confirmed reduction in hyperscaler capital expenditure could become an additional factor influencing semiconductor and technology valuations.
At the same time, Capital Economics expects European equities to continue outperforming relatively if the AI-related correction deepens, while US Treasury bonds could benefit from increased demand and changing interest rate expectations.
The firm’s outlook therefore identifies corporate earnings revisions, AI infrastructure spending and bond market developments as important factors for investors to monitor.