The S&P AI bubble is too big; gold and Chinese stocks may be the best hedging tools.

As the AI boom pushes US stock valuations to high levels, Bank of America strategist Michael Hartnett believes that gold and Chinese stocks are the best hedging tools in the current market environment to cope with potential AI bubble risks.

In a recent report, Bank of America’s Hartnett believes that “the leadership of AI stocks will not be shaken in the short term, and we prefer gold and Chinese stocks as the best hedging against prosperity/bubbles.”

The market capitalization of the S&P 500 index has surged by $17 trillion since the low in early April, and recently, chip giant Nvidia's market capitalization has surpassed $500 billion. Market sentiment seems to remain optimistic.

The strong earnings reports recently released by Amazon and Apple boosted US stock futures on Friday, with investors generally expecting that the US will experience robust economic growth, lower interest rates, and market-supportive policies potentially brought by Trump in 2026.

However, Hartnett's suggestion reveals the risks lurking beneath the optimism, namely that the AI-driven rally has led to market valuations significantly deviating from historical averages.

In this context, gold is seen as a tool for hedging against the potential resurgence of inflation due to economic expansion and loose policies, while Chinese stocks offer an alternative investment option that has shown strong growth potential this year.

High Valuation, Concerns of an AI Bubble Emerge

Bank of America's warning is primarily based on the current overvaluation levels of the U.S. stock market. Data shows that the forward price-to-earnings ratio of the S&P 500 index has reached 23 times, significantly higher than the average level of 16 times over the past two decades. So far this year, the S&P 500 index has risen by more than 16%.

The problem is particularly prominent among the “Mag7” tech giants. These companies account for more than one-third of the S&P 500 index, and their overall forward price-to-earnings ratio is as high as 31 times.

Despite the recent decline in Meta's stock price due to investor concerns that its massive AI investments are not yielding expected returns, which triggered a market correction, the overall trend has not reversed.

Gold and Chinese stocks provide diversified options

The Hartnett team believes that gold is an effective tool for hedging future inflation risks. The report points out that investors are positioning themselves for strong economic growth in 2026, with their expectations based on the Federal Reserve's interest rate cuts and the possibility of Trump introducing pro-market policies.

However, the combination of loose monetary policy and an expanding economy may become a breeding ground for inflation to rise again.

In this context, gold can play its traditional hedging value. Although gold prices have recently fallen from a historical high of over $4300 per ounce, the logic of its role as a hedging tool remains valid.

According to EPFR data, following four consecutive months of inflows, global gold funds experienced a record outflow of $7.5 billion in the past week.

In addition to gold, American bank strategists are also optimistic about Chinese stocks.

Since the beginning of this year, the performance of the Chinese stock market has significantly surpassed the S&P 500 index, with the MSCI China Index soaring by 33%. Behind this surge is the market's optimistic sentiment regarding China's competitive capabilities in the generative AI field, especially following the rise of AI models such as DeepSeek.

It is worth mentioning that after Trump was last elected president, Hartnett and his team correctly bet on international market stocks such as those in Asia and Europe, accurately predicting that the loose policies in these regions would drive the stock market up.