An AI 'reality check' may take the S&P 500 to 5,000. Here are the trades to make, this strategist says.

By Jamie Chisholm

Keep an eye on AI capex in the upcoming earnings season, says Panmure Liberum's Klement

A popping of the artificial-intelligence bubble may send the market down 35%.

The S&P 500 sits only about 1% from its record closing high as many investors are looking to third-quarter corporate earnings beginning mainly next week.

Shares of Nvidia (NVDA), the artificial-intelligence bellwether and the market's biggest company, are eyeing a fresh record high.

But Joachim Klement is definitely not running with the AI bulls. In a note published Monday, the research analyst for U.K. investment bank Panmure Liberum, alongside colleague Francisca Reis, said a downturn for the AI sector will cause the S&P 500 to fall to 5,000 by the end of next year.

He acknowledged the market's stoicism. "Stock markets have been remarkably resilient despite more and more obstacles put in their way," he said. "First, it was rising inflation, which remains stubbornly high. Then long-term bond yields rose to ever new heights and continue to do so to this day. Finally, the Fed and other central banks have started to hike rates."

Support for the market has come from strong earnings growth and robust economic data, particularly leading indicators like purchasing managers' indexes, he noted.

"But the upcoming Q3 earnings season and then the full-year earnings and guidance for 2027 in January will provide a critical reality check," Klement said.

Expanding on his pessimism around the AI trade, Klement told MarketWatch that, in essence, the market put itself into a bit of a capex pickle. He said investors do not want to see hyperscalers increasing the pace of their capex. Consequently, any great jump in spending by hyperscalers may clobber stocks that carry great weighting in the market.

Yet, if capex is curtailed, that may also be a problem. Klement noted that Goldman Sachs last week predicted that hyperscaler capex may hit $1.2 trillion in 2027.

The problem for the market, he said, is that once such numbers are bandied about, any significant capex shortfall will badly damage sentiment toward the beneficiaries of such spending, particularly chip and data-center equipment makers.

As sentiment about AI crumbles, Klement said the stock market could fall about 35% - hence his 5,000 target for the S&P 500. "I think the entire bubble will pop either in 2027 or 2028," he told MarketWatch.

"Add to that additional rate hikes by the Fed and Bank of England until the year-end, and the bull market in equities could come to an abrupt end sooner than many expect," Klement said.

He said that the best areas of the market during such a drawdown will be traditional defensive plays like food producers and sellers, pharmaceuticals and tobacco.

Utilities may also be a good bet, but not those that have been boosted by perceived AI energy demand, which leaves U.K. and German infrastructure plays as a better option. Bonds may receive a bid later in 2027, when the stock market slide eventually encourages a move into havens, he added.

But ultimately Klement said he would favor two basic positions during any AI implosion: "cash and fetal."

The markets

U.S. stock-indices SPX DJIA COMP opened little changed as Treasury yields BX:TMUBMUSD10Y crept higher. The dollar index DXY was up, as oil futures (CL.1) slipped and gold futures (GC00) traded around $4,185 an ounce.

 
Key asset performance                                                Last       5d      1m      YTD     1y 
S&P 500                                                              7722.72    -0.27%  0.05%   12.81%  14.99% 
Nasdaq Composite                                                     27,190.86  0.45%   2.58%   16.99%  19.36% 
10-year Treasury                                                     5.283      3.90    49.40   111.10  113.10 
Gold                                                                 4186.6     0.92%   -6.49%  -3.36%  5.08% 
Oil                                                                  90.79      -2.68%  -0.47%  58.14%  47.10% 
Data: MarketWatch. Treasury yields change expressed in basis points 

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The buzz

The dollar hit a 17-month high versus the euro (EURUSD) as the common currency remained rattled by political and bond market tension in France and fresh news of a snap election in Spain.

PTC shares (PTC) are surging after the industrial-design software company was acquired by France's electrical equipment maker Schneider Electric (FR:SU) in a $23 billion deal.

The U.S. administration is reportedly monitoring a suspected plague outbreak in Russia.

The iShares MSCI Brazil exchange-traded fund is surging after the right-wing Flávio Bolsonaro fared better than expected in the first stage of presidential polling.

U.S. economic data released on Monday include the Services purchasing managers index for September at 9:45 a.m. Eastern, and the ISM Report on Business Services PMI for last month at 10 a.m.

Spending on AI is becoming almost impossible for businesses to budget.

The chart

The utilities sector has had a tough time of late, with the State Street Utilities Select Sector SPDR ETF XLU pulling back 16% from its July all-time high, said the team at SpotGamma, an options-analytics firm. However, the XLU recently printed one of its largest call-volume sessions in two years, with more than 400,000 contracts changing hands. "When a seemingly washed-out sector begins attracting that degree of upside options activity, it may be worth paying attention," said SpotGamma.

Top tickers

Here were the most active stock-market tickers on MarketWatch as of 6 a.m. Eastern.

 
Ticker  Security name 
NVDA    Nvidia 
GME     GameStop 
TSLA    Tesla 
SPCX    SpaceX 
MU      Micron Technology 
AMZN    Amazon.com 
TSM     Taiwan Semiconductor Manufacturing 
AMD     Advanced Micro Devices 
INFY    Infosys 
AAPL    Apple 

-Jamie Chisholm

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(END) Dow Jones Newswires

10-05-26 0930ET