Strategist explains why the worst may be yet to come for AI stocks

 Capital Economics warned in a note on Monday that the sell-off in AI stocks could deepen, as analysts’ earnings forecasts for tech companies have yet to reflect investors’ growing worries.

“The AI correction in equities could have much further to run,” the research firm wrote.

Capital Economics noted that profit expectations for companies benefiting from AI spending have continued to soar in recent weeks, even as their share prices have fallen.

It said this may be partly because hyperscalers, the large cloud computing companies, have only doubled down on their spending plans.

However, the firm believes analyst estimates can be slow to react to news. It suspects there is still plenty of downside to those forecasts if sentiment keeps worsening. Any concrete sign that hyperscalers are scaling back capital spending would be a further risk, given that such spending underpinned the earlier gains in tech stocks.

European equities, by contrast, have weathered the storm well, with the MSCI Europe Index rising slightly last week. 

Capital Economics acknowledged that a larger sell-off could eventually weigh on Europe, as in past market plunges. However, it said the tech-heavy and concentrated nature of the AI boom might make this time different.

“We expect Europe to continue to outperform if the bubble deflates further,” the firm said.

It also expects the rally in Treasuries to continue, as further equity declines could drive demand for safe-haven assets. Furthermore, Capital Economics noted that any cuts to capex plans would lead investors to price in Fed rate cuts further ahead.

“We expect yields to fall a bit further,” the firm added.