Optimal "AI Bubble Trading": Going Long Both "Arrogance" and "Prejudice"

The optimal investment strategy in the current AI bubble environment is to go long both "hubris" (AI tech giants) and "humiliation" (out-of-favor, neglected assets), in order to capture dual returns in the final surge of the nominal GDP bubble.

According to Chasing the Wind Trading Desk, Bank of America Securities Chief Strategist Michael Hartnett stated in his latest report that the Bank of America Bull & Bear Indicator slipped slightly from 9.7 to 9.3, still in the extreme bullish range, maintaining a "sell" signal. Meanwhile, capital flows showed a structural divergence over the past week: tech stocks saw their largest weekly outflow in seven weeks, gold had its biggest weekly inflow since January, commodities returned as much as 58.9% year-to-date, while bitcoin suffered a nearly 28% decline this year.

Bank of America points out that the current core logic of asset allocation continues to be to avoid bonds, avoid the US dollar, and go all-in on AI, and this is further reinforced by policymakers treating the stock market as "too big to fail." However, strategists also warn that surging bond yields, a shift toward caution among voters, and an overall long-biased positioning are the three potential constraints limiting further upside for the bull market.

Bank of America's core AI thematic trading logic comes from comparisons with historical bubble patterns. The report states that the optimal bubble trading strategy is to go long both "hubris"—AI technology itself—and "humiliation"—cyclical assets that have been neglected by the market but are likely to surge in the final phase of nominal GDP's climb. The report cites historical examples: emerging markets during the 1999 internet craze, and the 2007-2008 subprime bubble, both played the role of "benefiting from spillover effects" just before the leading bubble peaked. Bank of America believes that under current conditions, the most likely asset class to follow this pattern is the consumer sector.

At the same time, Bank of America suggests shorting AI bonds—arguing that over $1 trillion in capital expenditure accompanied by negative net cash flow means significant bond issuance pressure cannot be ignored.

This week, the Bank of America Bull & Bear Indicator edged down from 9.7 to 9.3, maintaining a sell signal, triggered by weaker inflows into high-yield bonds and net outflows from the tech and healthcare sectors. The report notes that since the sell signal was triggered on May 26 this year, the S&P 500 index has risen 4%, and the MSCI World Index is up 3%, despite a maximum drawdown of 5% during the period (May 26 to July 30, interrupted by Bank of Japan FX interventions and strong earnings from the tech "Magnificent Seven").

Bank of America points out that excessive concentration can disrupt the bull market’s rhythm, but it still takes the resonance of three factors to truly end a bull market: over-positioning, overly optimistic earnings expectations, and policy tightening. Currently, all three criteria are not in place simultaneously. Historical data shows that since the establishment of the Bull & Bear Indicator, there have been 17 sell signals, and on average, global stocks declined 2%-3% in the following 2-3 months, with a hit rate of around 60% and maximum drawdowns between 15%-20%.

This week's fund flow data shows a clear structural split. Gold funds saw $6.3 billion in net inflows, the largest weekly figure since January; commodities posted a 58.9% total return so far this year, topping all asset classes, with oil up 43%. In contrast, tech funds witnessed net outflows of $1.2 billion, the largest weekly outflow in seven weeks. European equity funds saw $1.2 billion in net inflows, the biggest inflow since February; South Korean equity funds enjoyed net inflows for the seventh consecutive week.

In fixed income, investment grade bonds attracted $10.6 billion in inflows, the highest in five weeks; emerging market bonds took in $1.4 billion, the most in seven weeks. Cash assets drew $25.4 billion in a single week.

According to Bank of America private client data, with $4.7 trillion in assets under management, equity allocations have risen to 66.4%, a record high; bond allocations are down to 17.0%, the lowest since March 2022; cash allocations have fallen to 9.4%, an all-time low. Equity inflows for the week were the largest since September 2022.

Within bonds, private clients are slightly extending duration, with holdings of US Treasuries with maturities of 2-10 years up 15% year-to-date, while allocations to T-bills with maturities under one year fell more than 30% since last November. There is still a lack of interest in 30-year bonds. Over the past four weeks, private clients have bought Japanese bonds, municipal bonds, and inflation-protected bonds via ETF, while trimming emerging market debt, utilities, and financial sector ETFs.

Bank of America warns that US national debt is about to break $40 trillion and is forecast to reach $50 trillion by July 2029. The cost of servicing federal debt over the past 12 months already hit $1.4 trillion, and this cost will continue to rise unless the 5-year US Treasury yield falls below 3.25%. Meanwhile, the 30-year US Treasury was recently issued at a 25-year high yield of 5.126%, yet US stocks simultaneously hit a historic high, underlining the ongoing validity of the "avoid bonds" allocation logic.

Bank of America points out that despite upward pressure on yields heading into 2026, long-duration, previously underperforming assets such as REITs, small caps, biotech (XBI), and regional banks (KRE) are quietly outperforming, reflecting the market's early pricing in of a "yield peak". The report believes the Bank of Japan's FX intervention sent a clear signal that the US government does not want the 10-year Treasury yield to break 5%. Strategists expect core CPI to fall to the 2.1% to 2.6% range before the midterm elections, and hawkish Fed Chair Warsh may announce "mission accomplished" at Jackson Hole or the September FOMC, with Bank of Japan rate hikes helping jointly cap the yield upside.

Bank of America lists the November 3 US midterm elections as one of the most critical market events. The report notes that if Republicans keep the Senate and Texas Governor Abbott is re-elected, AI and risk assets are likely to accelerate upward into 2027; but if Democrats win the Senate or the Texas governorship in November, stocks, the dollar, and bond yields could all see sharp 10%+ reversals before year-end.

The Texas gubernatorial race is seen as a referendum between "affordability" and "AI data centers"—the state currently has 335 data centers and another 247 planned. Abbott recently announced a temporary pause on data center expansion, reflecting voter concerns about the stability of the power grid and living costs. Other key events highlighted by Bank of America include: August 28 Warsh’s Jackson Hole speech; the September 16 FOMC meeting (currently a 35% probability of a hike); and the September 18 Bank of Japan meeting (74% hike probability).