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% away from its record closing high as many investors are looking forward to third-quarter corporate earnings, beginning in earnest 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, says a downturn for the AI sector will cause the S&P 500 to fall to 5,000 by the end of next year.
He does acknowledge the market's stoicism. "Stock markets have been remarkably resilient despite more and more obstacles put in their way," he accepts. "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 manager indexes, he notes.
"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 says.
Expanding on his pessimism around the AI trade, Klement told MarketWatch that in essence the market has got itself into a bit of a capex pickle. He thinks 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.
And yet at the same time, if capex is curtailed, that may also be a problem. Klement notes that Goldman Sachs last week predicted that hyperscaler capex may hit $1.2 trillion in 2027.
The problem for the market, he believes, 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 sees the stock market falling 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 adds.
He thinks 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 a better option. Bonds may receive a bid later in 2027, when the stock market slide eventually encourages a move into havens, he adds.
But ultimately Klement says he would favor two basic positions during any AI implosion: "cash and fetal."
The markets
U.S. stock-index futures (ES00) (YM00) (NQ00) are lower as Treasury yields BX:TMUBMUSD10Y hold near recent highs. The dollar index DXY is higher, as oil futures (CL.1) slip and gold futures (GC00) trade around $4,190 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 single 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, notes 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," says 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