How to make defensive investments before the AI bubble pops
Jung Yeon-je/AFP via Getty Images Diversification has been a cornerstone of responsible investing practice for decades, but may be more crucial than ever in the midst of the stock market’s continued bull run, experts say. As analysts point out that positive stock market returns over the last few years have largely been thanks to a…
Diversification has been a cornerstone of responsible investing practice for decades, but may be more crucial than ever in the midst of the stock market’s continued bull run, experts say.
As analysts point out that positive stock market returns over the last few years have largely been thanks to a few outperforming tech companies (1), which many argue are overvalued, other patterns are emerging that could spell trouble for the average portfolio.
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That includes, as illuminated by veteran Wall Street commentator Jim Paulsen this week, higher general risk (and a severe dearth of traditional risk aversion) across indexes.
“Among all the AI excitement, investors have increasingly allowed the degree of risk aversion to fade from their portfolios,” Paulsen wrote in a July 2 post (2)to his Substack, where he shares market insights informed by his 40-year career as a strategist.
“What is becoming clear is that the S&P 500 index – and probably most portfolios — is becoming much riskier… [and] with risk aversion increasingly [missing], the chance of disappointing results has increased.”
The unseen tech exposure
Of primary concern to the everyday investor is that even if you’re not one to jump on the chip bandwagon or cancel your life insurance to invest it in tech ETFs (3), the very nature of America’s indexes right now leaves you more exposed to the potential fallout from an AI bubble than you may realize.
Many popular broad market index funds, such as those based on the S&P 500, are now about 40% weighted in tech (4). Alphabet [NASDAQ:GOOG], Amazon [NASDAQ:AMZN], Microsoft [NASDAQ:MSFT] and Meta [NASDAQ:META] — perennially in the S&P’s top 10 — are expected to put a collective $700 billion into artificial intelligence this year alone (5), meaning you’re likely in the AI game, like it or not.
Holdings across multiple ETFs won’t help, either, as they all overlap (6). And even funds billed as “international” are still heavily reliant on the U.S. market and economy,
As Paulsen and other experts have warned this year, most components of the market “are essentially failing,” opening a widening gap between “new era” and “old era” stocks. The two types historically move in the same direction during market highs, even if a small number are leading the charge — but this year, tech shares have been rising to record highs not just in isolation, but while traditionally safe and steady “defensive” stocks suffer.
Those defensive stocks currently make up about 17% of total S&P 500 market capitalization, close to a record low half of its peak during the early 1990s, Paulsen wrote, warning that “With [defensive stocks] now comprising such a small share of capitalization, expect wilder market swings during the balance of this bull market.”
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How to position yourself to be more defensive
If you don’t want to lean too much into the AI boom, you can diversify with funds or individual shares in essential non-tech sectors such as healthcare, consumer staples and regulated utilities. There are also broad-based funds that are less tech-weighted (7), while international markets, if investments are active and strategically selected (8), can provide more shielding and are often better priced, to boot.
Keep in mind that market segments like real estate (particularly data center or office and retail REITs (9)), some industrials and materials (10), unregulated or nuclear utilities (8), and financials will have indirect AI exposure. That being said, within these segments, precious metals like gold and silver, residential or self-storage REITs (11), and cash-generating physical real estate, depending on interest rates, could help you plant a more defensive position, as can some value equities (8) — just do your research.
Ensuring you have a maximum of 25% sunk into any given sector, and at most, 5% in any given position, are common best practices (6) for responsible diversification, as is moving 15% (12) to 20% of your stake abroad (13).
The traditional 60/40 rule of dividing your assets between equities and bonds has also been turned on its head in this new era, with some economists suggesting (14) that if you areokay with a bit of risk to get in on the AI party, you instead allocate 60% of your portfolio to AI-exposed markets and 40% to AI-proof investments.
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Article Sources
We rely only on vetted sources and credible third-party reporting. For details, see ourethics and guidelines.
CNBC (1); Substack (2); The Market House (3); Reuters (4); Yahoo Finance Canada (5); Guardfolio (6); Barron’s (7); Schroders (8); Urban Land (9); Oliver Wyman (10); Seeking Alpha (11); Saxo (12); Vanguard Investor (13); Yahoo Finance (14)
This article originally appeared on Moneywise.com under the title: ‘Portfolios are becoming much riskier’: How to make defensive investments before the AI bubble pops
This article provides information only and should not be construed as advice. It is provided without warranty of any kind.
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