AI bust could trigger 30% S&P 500 plunge, $20T wipeout - TS Lombard
An AI market crash could erase about $20 trillion from the value of the U.S. stock market, cause $125 billion to $190 billion in credit losses, and lead to a mild recession. But investors can protect themselves by holding a mix of stocks from around the world and buying bonds at the right time, according to Dario Perkins of TS Lombard.
In an analysis published Thursday, Perkins looked at what could happen if companies sharply cut their spending on AI. He estimated that the S&P 500 SPY VOO would fall by 30%. Technology stocks XLK would drop by 40%, while stocks in other sectors would fall by 20%.
"Market concentration means a downturn in AI-related spending would hit US equities hard," Perkins wrote. "It would trigger sizeable losses and credit stress across the tech sector."
Most credit losses would affect weaker parts of the AI industry. These include cloud computing companies that focus on AI, such as CoreWeave CRWV; companies that develop AI models on their own, such as OpenAI OPENAI and Anthropic ANTHROPIC; and companies that supply materials and services for construction. The biggest technology companies, known as hyperscalers, are expected to cope better because they have strong finances. These include META, AMZN, GOOG, GOOGL and MSFT. By late 2027, the parts of the AI industry outside these largest companies are expected to have about $545 billion in bonds, $920 billion in bank loans and $650 billion in private credit debt still outstanding.
Despite the potentially large losses in wealth, Perkins expects only a mild recession, similar to the downturns in 1990 or 2001. The end of the AI data-center boom could reduce U.S. gross domestic product (GDP) by about 2 percentage points and eliminate around 800,000 jobs related to construction. "But as far as recessions go, we don't think this one would be particularly severe," he said. He pointed to the healthy financial position of private businesses and the Federal Reserve's ability to cut interest rates if needed.
Fresh concerns about whether AI spending can last, how much it costs and whether it will bring enough business benefits pushed investors away from stocks, especially technology shares AIQ AIEQ pushed investors and QQQ, and toward the relative safety of government bonds on Thursday. This happened after Meta Platforms META and IBM IBM gave earnings reports that raised concerns.
For investors dealing with this uncertainty, Perkins advised waiting patiently and spreading investments across different assets rather than making big bets against stocks. "We don't know exactly when this AI capex splurge will end," he said. "Investors who try to short US tech (or add duration) too early will surely underperform."
His recommended approach is to keep a normal level of investment risk while holding a mix of stocks from different countries VXUS. This portfolio should do reasonably well if the AI boom continues and perform better if the market crashes. "This bubble is not like Dotcom because it is much more concentrated on the US and the AI supply chain," Perkins explained. He noted that markets outside the U.S. VEU are not as heavily focused on one investment theme.
Perkins said investors should add government bonds SHY TLT ZROZ IEF "only once signs of fragility emerge." The report expects long-term interest rates to fall sharply if the Federal Reserve responds to a drop in demand caused by an AI downturn. The U.S. dollar DXY, meanwhile, "is ultimately headed lower" because the damage would be centered on the U.S. financial system.