AI optimism could boost S&P 500 to 7,000 next year, says economist

By Isabel Wang

AI's boost to economic productivity will be substantial, but it won't arrive until the second half of this decade: Capital Economics

Artificial intelligence has helped propel the U.S. stock market to a string of all-time highs this year, while helping Nvidia Corp., Microsoft Corp. and Apple Inc. generate superpowered corporate profits.

Capital Economics' top economist, Neil Shearing, thinks AI enthusiasm could also help the S&P 500 index SPX reach a peak of 7,000 in 2025, even though he also sees parallels to the previous "dot-com bubble."

"The experience of the dot.com bubble suggests that U.S. equity valuations can rise further - and the anticipation of additional multiple expansion fueled by AI optimism is why we think the S&P 500 may peak at 7,000 next year," Shearing wrote, in a Monday client note.

One area, however, where AI will likely take longer to have a major impact is the U.S. economy, even though recent innovations, like the internet, have been more quickly filtering through to the economy (see chart below) than in the past.

For example, it took over 70 years for the steam locomotive to become widely adopted after its invention. The adoption lag was cut to five to ten years for the information and communication-technology revolution of the 1980s and 1990s, according to Capital Economics.

By the mid-1990s, the effects of technology became visible in economic data, and over the second half of the decade, U.S. productivity expanded at roughly double the pace it did in the 1980s, Shearing wrote.

He sees the AI revolution starting to feed through to the economy only in the second half of this decade.

See: The AI 'bubble' has helped the U.S. stock market dominate the world. What happens if it bursts?

The seemingly unstoppable rally in shares of Nvidia Corp. (NVDA) and other AI-related companies has some investors fearing the hype around the technology.

Indeed, Shearing said what appears to be happening is that AI is following the "Gartner Hype Cycle," which illustrates how public views about the impact of new technologies evolve over time (see chart below).

"We must surely be somewhere close to the peak of inflated expectations, at least as far as the macroeconomic impact of AI is concerned. This suggests that we will now go through a period of skepticism before we reach peak pessimism and, eventually, the productivity benefits start to reveal themselves," Shearing said.

Nvidia's investors are part of a long tradition of attempting to capture the benefits of a new technology before it fully materializing in the economy, which leads to growing doubts about the ultimate economic benefits of this AI revolution, Shearing said.

He added that this type of concern may be able to explain the recent volatility in Nvidia's shares, which fell over 13% between June 20 and the 24th before partially recovering last week. Nvidia's stock was roughly unchanged on Monday afternoon, according to FactSet data.

See: Is Nvidia doomed to be the next Cisco or Intel? Here's what investors need to know.

The large-cap benchmark S&P 500 index has advanced nearly 15% so far in 2024, ending at 5,475.09 on Monday afternoon.

U.S. stocks finished higher on Monday to kick off a shortened, four-day week that includes the Fourth of July holiday. The Nasdaq Composite COMP advanced 0.8%, while the Dow Jones Industrial Average DJIA was up 0.1% and the S&P 500 SPX rose nearly 0.3%, respectively, according to FactSet data.

-Isabel Wang

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07-01-24 1606ET

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