The S&P 500 sits only about 1% from its record closing high as many investors are looking to third-quarter corporate earnings beginning mainly next week.

Shares of Nvidia, the artificial-intelligence bellwether and the market’s biggest company, are eyeing a fresh record high.

But Joachim Klement is definitely not running with the AI bulls. In a note published Monday, the research analyst for U.K. investment bank Panmure Liberum, alongside colleague Francisca Reis, said a downturn for the AI sector will cause the S&P 500 to fall to 5,000 by the end of next year.

He acknowledged the market’s stoicism. “Stock markets have been remarkably resilient despite more and more obstacles put in their way,” he said. “First, it was rising inflation, which remains stubbornly high. Then long-term bond yields rose to ever new heights and continue to do so to this day. Finally, the Fed and other central banks have started to hike rates.”

Support for the market has come from strong earnings growth and robust economic data, particularly leading indicators like purchasing managers’ indexes, he noted.

“But the upcoming Q3 earnings season and then the full-year earnings and guidance for 2027 in January will provide a critical reality check,” Klement said.

Expanding on his pessimism around the AI trade, Klement told MarketWatch that, in essence, the market put itself into a bit of a capex pickle. He said investors do not want to see hyperscalers increasing the pace of their capex. Consequently, any great jump in spending by hyperscalers may clobber stocks that carry great weighting in the market.

Yet, if capex is curtailed, that may also be a problem. Klement noted that Goldman Sachs last week predicted that hyperscaler capex may hit $1.2 trillion in 2027.

The problem for the market, he said, is that once such numbers are bandied about, any significant capex shortfall will badly damage sentiment toward the beneficiaries of such spending, particularly chip and data-center equipment makers.

As sentiment about AI crumbles, Klement said the stock market could fall about 35% — hence his 5,000 target for the S&P 500. “I think the entire bubble will pop either in 2027 or 2028,” he told MarketWatch.

“Add to that additional rate hikes by the Fed and Bank of England until the year-end, and the bull market in equities could come to an abrupt end sooner than many expect,” Klement said.

He said that the best areas of the market during such a drawdown will be traditional defensive plays like food producers and sellers, pharmaceuticals and tobacco.

Utilities may also be a good bet, but not those that have been boosted by perceived AI energy demand, which leaves U.K. and German infrastructure plays as a better option. Bonds may receive a bid later in 2027, when the stock market slide eventually encourages a move into havens, he added.

But ultimately Klement said he would favor two basic positions during any AI implosion: “cash and fetal.”