Investors have already taken a severe beating recently, but there’s much more stock market carnage in store as the AI investment boom wanes, according to Capital Economics.
In a note on Friday, Chief Economic Adviser Vicky Redwood said AI still has potential to boost productivity but is bearish about the amount of revenue that can be generated to sustain the rate of investment.
A handful of hyperscalers are expected to spend $800 billion this year, double from a year ago, and invest an estimated $1 trillion or more in 2027. Many forecasts assume annual capital expenditures will remain above $1 trillion for several years.
But Redwood calculated that annual AI-related revenues earned from external customers would have to explode by 10-fold by 2030 to justify all that spending. While that’s possible, it implies a much more severe and rapid disruption to the economy than currently seen, such major displacement of existing businesses and labor.
As a result, she thinks investment will continue to rise next year but at a slower pace—then fall outright in 2028 by around 10%.
Given that higher AI investment added 0.3 percentage point to U.S. GDP growth last year, a capex slowdown should trim that much from its recent growth rate, Redwood estimated, and a 10% capex drop might take 0.1% off GDP.
That’s actually just a slight haircut, especially compared to more AI-dependent economies in Asia. Taiwan’s real GDP growth next year should be around 3 percentage points lower, and South Korea’s should be 1 point lower, with a further drag in 2028.
Meanwhile, the stock market will price in the looming AI capex drop even sooner. Redwood expects the S&P 500 will be 12% below its current level by the end of 2027, putting it 17% off its early-October peak.
“We expect considerably larger falls in tech-heavy indices,” she added. “A tightening of financial conditions driven by factors such as higher energy prices or term premia could also make financing investment hard.”
Lower stock prices will also feed into the economy via the wealth effect, which fuels consumer spending. The market’s rally over the past year lifted GDP by around 0.4%, according to Redwood, so a stock selloff should produce an economic drag of similar scale.
Despite the warnings about capex, GDP and stocks, AI will continue to work its way into the economy and improve productivity, helped by the infrastructure that’s already been built and the new investment that’s on the way, albeit at a slower rate.
In fact, capex could remain relatively high even after declining, Redwood pointed out, as hyperscalers keep spending to replace depreciating equipment, exploit economies of scale, and stay ahead in the “winner-takes-most” AI race. They could also spread out any investment declines over several years instead of all at once.
“The bottom line for the U.S. economy is that we expect slower GDP growth in 2028, but not a major downturn,” Redwood wrote. “Admittedly, recessions have sometimes followed previous capex booms and busts, including in the early 2000s after the dotcom bust. However, a fall in capital spending alone has generally not been sufficient to cause a recession.”
At the same time, AI adoption should continue to expand, boosting productivity and supporting output growth. Redwood estimated that AI will increase U.S. productivity by about 1% per year for several years.
She does not expect an abrupt collapse in AI investment or a severe economic downturn when the boom ends.
“Rather, we expect investment to adjust to a more sustainable pace, with sufficient capacity still being added to support further growth in AI usage,” she concluded.