Key Insights

• A memo from a strategist at Bank of America indicates that, despite significant rises over the past few years, the top seven stocks have not yet reached levels that historically indicate a peak bubble.
• The “Magnificent Seven” has seen approximately a 60% increase since a low in early April, fueled by optimism around AI, solid revenues, and low interest rate expectations.
• Bank of America strategists propose that investors can protect themselves against potential high-tech bubbles by offloading undervalued stocks and shorting the debt of overpriced tech companies.

According to a strategist from Bank of America, the current rally driven by AI in big tech stocks still has potential for growth, offering investors some strategies to navigate a possible AI bubble.

Analysts, led by Michael Hartnett, reveal that historically, the average rise from the start to peak in stock bubbles since 1900 has been about 244%. At the peak, the average price-to-earnings (P/E) ratio is typically 58, with stocks sitting around 29% above the 200-day moving average.

Hartnett describes the “Magnificent Seven” as a strong indicator of the current bubble environment. Since March 10, 2023, this prominent tech stock group has surged by 225%, now trading at a P/E of 39 and roughly 20% above the 200-day average. This data suggests it’s premature to conclude they’re at a bubble peak.

Despite ongoing warnings from market analysts about a potential tech bubble, investor enthusiasm for the Magnificent Seven remains strong.

This year’s rally has been quite eventful. Back in January, a Chinese startup, Deepseek, created waves in the tech market with its very effective inference model. However, shares of the Magnificent Seven saw considerable drops in March and April due to uncertainty surrounding President Trump’s tariffs.

Since their significant drop on “Liberation Day” in early April, these stocks have rallied back about 60%. While AI optimism plays a role, factors like a lax regulatory and tax environment under Trump, coupled with strong revenues and hopes for lower interest rates, have also contributed. Notably, the Federal Reserve cut fees recently for the first time since December, enhancing this optimism.

Strategies for Navigating Bubbles

With stocks reaching all-time highs and the returns from AI investments still uncertain, Hartnett and his team suggest several strategies to hedge against potential AI bubbles.

One recommended approach is a barbell strategy. Analysts note that asset bubbles can drive economic growth, boosting undervalued stocks. They cite the dot-com bubble, where the only market outperforming the Nasdaq from October 1998 to March 2000 was Russia. Current equivalents might include Brazilian stocks, which are trading at around a 9 P/E, along with UK stocks and global energy stocks.

Another strategy for tackling bubbles involves shorting the bonds of overvalued stocks. Hartnett notes that credit reflects balance sheet weaknesses before stocks do, pointing to the dot-com era when tech bonds started showing declining performance before the bubble burst.