Watch for these warning flags in the hot AI trade for 2026, says this market bull

MW Watch for these warning flags in the hot AI trade for 2026, says this market bull

By Jamie Chisholm

Expect more volatility for stocks next year, says Evercore's Emanuel

Traders will be closely watching the AI sector for signs of stress

Most of the bullish calls by analysts for the stock market in 2026 include a continuation of the artificial intelligence trade.

Julian Emmanuel, strategist at Evercore ISI, is no different. His price target for the S&P 500 SPX in a year's time is nearly 12% up from Friday's close, driven by more AI-related gains, U.S. fiscal stimulus, and corporate earnings growth.

However, Emanuel does expect increased market volatility in 2026, and he recognizes that concerns about systemic AI risk has tarnished the tech sector somewhat of late.

Currently, those risks are "largely absent," he reckons. Nevertheless, he offers up several signals that may flag problems ahead.

First, is the further expansion of what Emanuel terms the "circular AI economy." This could breed "risks similar to past periods of exuberance such as 1980's keiretsu in Japan and Dot.Com's 'vendor financing' schemes," he says.

Keiretsu is the name given to Japan's networks of companies linked by mutual shareholdings. "Today, the circular AI economy consists of similar relationships as Mag 7 investments in AI darlings such asOpenAI and Anthropic have risen," Emanuel notes.

He stresses that while big tech is increasingly investing in AI companies, the amount of cross-shareholding is still relatively low. However, "businesses owning 10% of total equities, similar to the Y2K's top, would highlight a major 'red flag,'" he says.

Source: Evercore ISI

Another possible warning flag is a notable deterioration in hyperscalers' balance sheets. Currently, nearly all of them hold more cash than debt. But "a flip to 10% net debt/market cap would be a 'yellow flag,'" Emanuel says.

Similarly, while the sector's current free cash flow is sizeable, downward revisions "would be worrisome, a flip negative [would be] a 'red flag,'" he adds. Note how expectations for negative FCF at Oracle $(ORCL)$ have hit the stock in recent months.

Source: Evercore ISI

The ability to easily cover interest on debt should also be watched. The hyperscalers' interest coverage ratio ( measured by earnings before interest and tax divided by interest expenses) on aggregate is 44 times. That shows little strain in servicing debt payments.

But if that should fall to the S&P 500 median of 10 times, it "would raise a yellow flag that debt payments are becoming burdensome," says Emanuel.

Switching to the broader market, Evercore will be keeping an eye on evidence of stress in credit, which may be shown by five-year investment grade and high yield credit default swap indices widening beyond 57 and 350 respectively. CDS are insurance contracts on a debt default.

Sill, Emanuel concludes: "With none of the flags pointing to elevated systemic risks, EVR ISI Strategy continues to see S&P 500 ending 2026 at 7,750, with the potential for a bubble forming at 30%."

Evercore remains overweight AI-exposed information technology, communication services and consumer discretionary stocks.

The markets

U.S. stock-index futures (ES00) (YM00) (NQ00) are mostly lower as benchmark Treasury yields BX:TMUBMUSD10Y dip. The dollar index DXY is little changed, while oil prices (CL.1) rise. Gold (GC00) and silver (SI00) futures have succumbed to profit taking after surging to fresh record highs in recent sessions.

   Key asset performance                                                Last       5d      1m      YTD      1y 
   S&P 500                                                              6929.94    0.75%   1.72%   17.82%   17.32% 
   Nasdaq Composite                                                     23,593.10  2.55%   1.63%   22.18%   17.85% 
   10-year Treasury                                                     4.116      -4.80   2.40    -46.00   -42.70 
   Gold                                                                 4484.6     0.09%   5.15%   69.92%   71.17% 
   Oil                                                                  57.84      -0.19%  -2.81%  -19.52%  -18.68% 
   Data: MarketWatch. Treasury yields change expressed in basis points 

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U.S. economic data due Monday includes pending home sales for November, due at 10:00 a.m. Eastern.

China launched military exercises around Taiwan. The move is rattling U.S.-listed Chinese shares, such as Alibaba $(BABA)$, down 3%.

SoftBank Group (JP:9984) is in advanced talks to acquire DigitalBridge $(DBRG)$, a private equity firm that invests in assets such as data centers, according to a report.

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-Jamie Chisholm

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December 29, 2025 06:45 ET (11:45 GMT)

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