Capital Economics is raising concerns that the current significant shifts in U.S. stocks may indicate an impending stock market bubble set to burst in 2027, which could lead to a prolonged period of instability across major indexes.
On February 20th, John Higgins, the chief market economist at Capital Economics, suggested that the recent better performance of small-cap, value, and defensive stocks—compared to large-cap, growth, and cyclical stocks—mirrors trends observed in the latter phases of the dot-com boom. He noted, “If the aftermath of the dot-com era is a guide, we expect to see a stock market bubble in 2027, potentially followed by years of small-cap and value stocks outperforming.”
From this angle, Higgins elaborated that the recent shift in stock values from technology to more value-focused sectors like energy might signal forthcoming challenges and a significant transition in the market.
Similarities to the dot-com era
This year, the MSCI index tracking small-cap, value, and defensive stocks has outperformed large-cap, growth, and cyclical ones by nearly 10 percentage points in total returns, as per Capital Economics. The overlap between these groups complicates the overall movement. This shift initially took root quietly in late 2025, picking up speed in the early weeks of 2026, even as the broader U.S. market continued to rise above historical averages.
Higgins cautioned that it might be premature to declare a permanent shift in market leadership since the change is still only beginning in the context of a post-global financial crisis bullish phase. He pointed out the stark similarities to the lead-up to the 2000 crash, when small-cap stocks started to outperform large-cap stocks approximately 11 months before the dot-com bubble burst. In that period, large growth stocks dominated for four years until a pivotal moment in April 1999.
One key difference today is the timing within investment styles. In the dot-com cycle, value stocks only started to surpass growth stocks after the bubble had already burst. In contrast, value stocks are already leading early in 2026, lending a slightly different perspective to the current scenario.
The memo minimizes the influence of any potential political or legal events affecting this year’s drastic market moves. Higgins doesn’t anticipate the latest rotation in U.S. stocks to be heavily influenced by the Supreme Court ruling declaring President Trump’s IEEPA tariffs illegal, even if the administration looks for other ways to boost tariff revenue. He added that the economic fallout from such efforts might not be substantial, especially when compared to last year’s “Liberation Day,” which caused significant fluctuations across small- and large-cap stocks, as well as in value and growth categories.
Instead, the firm posits that market intelligence plays a more critical role. The combination of rising headline indexes, heightened investor interest in valuations, and behind-the-scenes leadership changes aligns with their broader theory that U.S. stocks may be nearing the end of a bubble phase. Capital Economics argues that the current trend suggests investors are starting to explore more distressed market segments and are becoming wary of the risks associated with the mega-cap growth trade.
Differences from the dot-com era
While the recent strong performance of small-cap, value, and defensive stocks could indicate a late-cycle alert, it might also simply represent a standard reassessment of risks and valuations rather than an imminent crash. Such rotations have happened in the past without subsequent market collapses, and often reflect a healthy market response to what former Federal Reserve Chairman Alan Greenspan characterized as “irrational exuberance.”
The parallels with the dot-com period are intriguing, yet selective. The extreme valuations seen in a limited number of unprofitable tech companies from the late 1990s differ significantly from today’s landscape of mega-cap firms with robust earnings and established market positions, alongside strong cash flows.
A genuine bubble typically manifests as a significant disparity between prices and underlying earnings, cash flow, and balance sheet strength. Although today’s leaders, particularly in tech and AI-related sectors, might seem pricey, a part of that premium is underpinned by solid profitability, long-term growth prospects, and high returns on capital. These fundamentals could justify a higher valuation multiple, allowing earnings growth to align with valuation over time.
