A shift in U.S. Equity performance is raising concerns among analysts at Capital Economics, who warn a potential stock market bubble could burst in 2027. The firm’s analysis, released February 20, 2026, points to a rotation in stock leadership mirroring patterns observed before the dot-com crash.
Chief Markets Economist John Higgins argues the recent outperformance of small-cap, value, and defensive stocks—relative to their large-cap, growth, and cyclical counterparts—echoes the final stages of the late 1990s tech boom. According to Capital Economics, these indices have outperformed by roughly 10 percentage points on a total-return basis so far this year.
“If the aftermath of the dotcom era is any guide,” Higgins wrote in the note, “the bursting of the next bubble in the stock market—which we forecast will occur in 2027—might be followed by periods in which small-cap and value stocks outperformed their peers for a very long time.”
The rotation began in late 2025 and has “gathered momentum” in early 2026, despite overall U.S. Market valuations remaining historically high. Capital Economics notes a similar pattern emerged in April 1999, when U.S. Small caps began to outperform large caps approximately 11 months before the dot-com bubble burst.
However, the current rotation differs in one key aspect. While value stocks only began to outperform growth stocks after the dot-com bubble burst, value is already leading growth in early 2026, suggesting a potentially different dynamic this time around.
Capital Economics downplays the influence of recent political events on the market shift. Higgins does not anticipate the Supreme Court’s February ruling deeming President Donald Trump’s IEEPA tariffs illegal to significantly impact the current equity rotation, even if the administration pursues alternative revenue-raising measures. The firm believes the economic consequences of such efforts would likely be limited, contrasting with the market reactions observed during the “Liberation Day” period in 2025.
The firm’s analysis suggests market internals are a more significant signal. Elevated headline indices, increasing investor focus on valuations, and the shift in market leadership align with Capital Economics’ broader view that U.S. Equities are in the late stages of a bubble. This pattern, they argue, indicates investors are exploring undervalued sectors and hedging against a potential unwinding of the mega-cap growth trade.
Despite the parallels to the dot-com era, Capital Economics acknowledges key differences. The late 1990s saw extreme valuations concentrated in unprofitable tech companies, a contrast to today’s landscape of large, profitable firms with strong market positions and substantial cash reserves. These fundamentals, the firm suggests, could support current valuations and allow earnings growth to catch up over time.
In a December 17, 2025 report, Capital Economics stated it expects the AI rally to continue through 2026, forecasting strong gains in equity markets most exposed to the technology, particularly in the U.S. And parts of Asia. However, the firm also anticipates a correction will eventually occur, though its base case predicts this will not happen until 2027.
The firm also forecasts the 10-year Treasury yield will be broadly unchanged in 2027, the year it anticipates the stock market correction.
