Capital Economics flags defensive sectors as AI trade risks deepen in U.S. market

Traders Union
All News
Stocks
Defensive sectors as AI risks rise

Highlights

Capital Economics warns the S&P 500 could drop about 16% to 6,500 by end-2027 if the AI boom deflates or collapses.
The firm highlights that real estate and consumer staples should outperform in an AI-led selloff, as lower Treasury yields cushion losses.
Recent results from Alphabet and Meta show negative free cash flow amid heavy AI-driven capital expenditures, fueling concerns about sector returns.

Defensive positioning as AI rally slows

As reported by CNBC, citing Capital Economics, the firm argues in a Thursday research note that traditional defensive sectors offer the best shelter if the AI trade continues to lose momentum or breaks more sharply. It says the S&P 500 could eventually fall to 6,500 by the end of 2027 if the AI boom keeps deflating or turns into a full bust, implying a decline of about 16%.

The firm still sees room for a final market rally led by technology stocks this year, but says the next 12 months may favor more defensive positioning. Capital Economics had already taken a bearish view in early September, when senior markets economist James Reilly wrote that the AI equity boom was nearing an end.

If the downturn in AI-linked shares deepens, Capital Economics expects U.S. Treasury yields to fall, which would support bond prices and help cushion losses elsewhere in portfolios. The firm says the 10-year Treasury yield fell in all eight episodes since 1995 when the PHLX Semiconductor Sector Index dropped 35% or more.

Real estate and staples seen as relative havens

Lower yields would make real estate one of the more resilient sectors, according to the note, although Capital Economics says the group would still decline in an AI-led selloff, just less than the broader market. Consumer staples may offer even stronger protection, with the firm pointing to the sector's gains after technology stocks peaked in early 2000.

The caution comes as investors question whether heavy AI spending by megacap technology companies is producing sufficient returns. Meta Platforms, Microsoft, Amazon and Alphabet have committed billions of dollars to infrastructure such as data centers and chips, while elevated capital expenditure is pressuring cash flow and profits.

Alphabet reported disappointing earnings late Wednesday that showed negative free cash flow in the third quarter. Meta, the parent of Facebook and Instagram, also reported negative free cash flow in its latest earnings last week while raising the lower end of its full-year capital expenditure commitment.

Capital Economics says energy and financials may be less reliable as defensive plays this time than in past technology selloffs. The firm argues those sectors have recently benefited more from supply shocks, especially in energy markets, and from higher Treasury yields than from any insulation from AI-related risks.

In our earlier analysis of the S&P 500’s slide driven by tech and semiconductor weakness, we noted that investors were increasingly questioning the durability of AI-related spending as borrowing costs and Treasury yields climbed. We also highlighted that the index was trading below key short-term moving averages, pointing to fragile near-term sentiment and elevated volatility as traders watched critical support and resistance levels.

This material may contain third-party opinions, none of the data and information on this webpage constitutes investment advice according to our Disclaimer. While we adhere to strict Editorial Integrity, this post may contain references to products from our partners.