AI exuberance: Economic upside, stock market downside

In this global outlook summary, our global chief economist highlights the top-level findings of Vanguard’s full economic and market outlook to be released in December.

Financial markets are exuberant—and there are some good reasons for that. Despite megatrend headwinds in 2025 like demographic slowdowns and rising tariffs, economies held firm. U.S. corporate earnings growth and fundamentals stayed strong, powered by AI investment and other positive technology shocks.

Our data-driven megatrends framework shows these supply-side forces will shift again in 2026. How well AI investment will counteract negative shocks shapes our economic outlook. Over the next five years, we see an 80% chance that economic growth diverges from consensus expectations. These projections shape our investment outlook and offer somewhat unconventional —yet increasingly compelling—investment opportunities for increasingly frothy financial markets. 

Higher growth is on the horizon, particularly for the U.S.

We anticipate that AI will stand out among other megatrends, given its capacity to transform the labor market and drive productivity. AI investment’s outsized contribution to economic growth represents the key risk factor in 2026.

The ongoing wave of AI-driven physical investment is expected to be a powerful force, reminiscent of past periods of major capital expansion such as the development of railroads in the mid-19^th century and the late-1990s information and telecommunications surge. Our analysis suggests that this investment cycle is still underway, supporting our projection of up to a 60% chance that the U.S. economy will achieve 3% real GDP growth in the coming years—a rate materially above most professional and central bank forecasts.

But this future is not quite now. In 2026, the U.S. is positioned for a more modest acceleration in growth to about 2.25%, supported by AI investment and fiscal thrust from the One Big Beautiful Bill Act. The first half of the year may be softer given the lingering effects of the stagflationary megatrend shocks of tariffs and demographics, as well as yet-to-materialize broad-based gains in worker productivity. The labor markets, which cooled markedly in 2025, should stabilize by the end of 2026, helping the unemployment rate to stay below 4.5%.

Economic growth is expected to keep U.S. inflation somewhat persistent, remaining above 2% by the close of 2026. This combination of solid growth and still-sticky inflation suggests that the Federal Reserve will have limited scope to cut rates below our estimated neutral rate of 3.5%. Our Fed forecast is a bit more hawkish than the bond market’s expectations.

Given similar AI-related dynamics, our forecast for China’s economic growth is also above consensus expectations in 2026. Despite ongoing external and structural challenges, real GDP growth is more likely to register 5% than 4%.

Conversely, our risk assessment for the euro area is more consensus-like given the lack of strong AI dynamics. We anticipate growth to hover near 1% in 2026, as the drag from higher U.S. tariffs is offset by increased defense and infrastructure spending. Inflation should stay close to the 2% target, allowing the European Central Bank to maintain its current policy stance throughout the year. 

A differentiated investment playbook

Our capital markets outlook differs across markets, asset classes, and investment time horizons. Overall, our medium-run outlook for multiasset portfolios remains constructive, with positive after-inflation returns likely to continue. In 2026, U.S. technology stocks could well maintain their momentum given the rate of investment and anticipated earnings growth.

But let us be clear: Risks are growing amid this exuberance, even if it appears “rational” by some metrics. More compelling investment opportunities are emerging elsewhere even for those investors most bullish on AI’s prospects. Our conviction in this view is growing, and it parallels investment returns in previous technology cycles.

Our capital markets projections show that the strongest risk-return profiles across public investments over the coming five to 10 years are, in order:

1. High-quality U.S. fixed income.
2. U.S. value-oriented equities.
3. Non-U.S. developed markets equities.

We maintain our secular view that high-quality bonds (both taxable and municipal) offer compelling real returns given higher neutral rates. Returns should average near current portfolio income levels, representing a comfortable margin over the rate of expected future inflation. That’s the primary reason why bonds are back, regardless of what central banks do in 2026. Importantly, U.S. fixed income should also provide diversification in a world where AI disappoints, leading to lower growth—a scenario with odds that we calculate to be 25%–30%.

We remain most guarded in our assessment of U.S. growth stocks, which admittedly have outperformed most other investments by an astounding margin. Yet as we will show in this outlook, our muted expected returns for the technology sector are entirely consistent with our more bullish prospects for an AI-led U.S. economic boom.

The heady expectations for U.S. technology stocks are unlikely to be met for at least two reasons. The first is the already-high earnings expectations, and the second is the typical underestimation of creative destruction from new entrants into the sector, which erodes aggregate profitability. Volatility in this sector—and hence the U.S. stock market overall— is very likely to increase. Indeed, our muted U.S. stock forecast of 4%–5% average returns over the next five to 10 years is nearly singlehandedly driven by our risk-return assessment of large-cap technology companies.

The history of investing during technology cycles reveals some counterintuitive—yet increasingly compelling—investment opportunities regardless of whether AI proves transformative or not. Both U.S. value-oriented and non-U.S. developed markets equities should benefit most over time as AI’s eventual boost to growth broadens to consumers of AI technology. Economic transformations are often accompanied by such equity market shifts over the full technology cycle.

Overall, these three investment opportunities are both offensive and defensive. This risk assessment holds no matter whether today’s AI exuberance ultimately proves rational or not.

IMPORTANT: The projections and other information generated by the Vanguard Capital Markets Model (VCMM) regarding the likelihood of various investment outcomes are hypothetical in nature, do not reflect actual investment results, and are not guarantees of future results. Distribution of return outcomes from the VCMM are derived from 10,000 simulations for each modeled asset class. Simulations are as of October 31, 2025. Results from the model may vary with each use and over time. For more information, please see the Notes section.

Related Links

• What the conventional economic wisdom is missing
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• Our economic outlook for the United States
• Vanguard’s economic and market views