LIVE MARKETS-It's all down to you, AI

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IT'S ALL DOWN TO YOU, AI

While artificial intelligence investments helped the economy survive "megatrend headwinds" in 2025, Vanguard's global chief economist Joe Davis sees AI as the "key risk factor in 2026."

"How well AI investment will counteract negative shocks shapes our economic outlook," he wrote in the company's 2026 outlook summary.

Davis sees ongoing AI-related investments creating a powerful force like the mid-19th century's railroad development and the technology and telecommunications boost in the late-1990s.

As a result, the economist "sees a 60% chance that the U.S. economy will achieve 3% real GDP growth in the coming years."

But in 2026, he expects more modest U.S. growth of about 2.25%, thanks to AI and the One Big Beautiful Bill Act.

However, the first half of 2026 may be softer due to lingering stagflationary effects from tariffs and demographics. And he notes "yet-to-materialize broad-based gains in worker productivity."

After labor market cooling in 2025, Davis sees stabilization by year-end 2026 keeping unemployment below 4.5%.

And with his expectation that U.S. inflation ends 2026 still above 2%, "the Federal Reserve will have limited scope to cut rates" below 3.5%, Vanguard's estimated neutral rate. However, Davis says his Fed forecast is more hawkish than the bond market.

U.S. technology stocks "could well maintain their momentum given the rate of investment and anticipated earnings growth" in 2026, he writes.

But the economist notes risks "amid this exuberance, even if it appears 'rational' by some metrics."

And he sees better "investment opportunities are emerging elsewhere even for those investors most bullish on AI’s prospects."

In a world where AI disappoints - a scenario where he calculates the odds as 25-30% - the economist suggests U.S. fixed income for diversification.

The firm is most guarded about U.S. growth stocks and Davis says "heady expectations for U.S. technology stocks are unlikely to be met" due to high earnings expectations and "underestimation of creative destruction from new entrants."

With this, volatility is "very likely to increase." And Vanguard's muted forecast for average U.S. stock returns of 4%-5% in next 5-10 years "is nearly singlehandedly driven by our risk-return assessment of large-cap technology companies," Davis writes.

(Sinéad Carew)

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