How to avoid the AI stock market bubble
Not only are stock market valuations stretched, but on the metrics that are most reliable for predicting future returns, the U.S. market is at an all-time high. We can say that factually and therefore categorically. It’s not a matter of opinion.
It’s worth remembering to bring everything back to the data to avoid the influence of emotions.
The important question then is not whether reducing your exposure and rebalancing portfolios results in a missed opportunity to maximise gains, but whether you’ll regret not doing that, and instead of retiring in two years, being forced to work for another six or seven. Indeed, and upon reflection, there will always be regret; the decision is about which regret is worse. Letting gains evaporate might be worse than missing out on a few more dollars.
This article was first published in The Australian on 05 November 2025.
Right now, there are a multitude of influences for investors to consider, including the long-term impact of the advent of humanoid robots being released for sale, coinciding with Amazon announcing 30,000 job cuts and other companies including, but not limited to, UPS (48,000), Intel (24,000), Nestle (16,000), Accenture (11,000), NovoNordisk (9,000) and Microsoft (14,000) doing likewise. There’s also the issue surrounding the U.S. Federal Reserve’s (the Fed) independence, with Jerome Powell’s term as Fed chair terminating on May 15, 2026. The likely replacement will be a Trump loyalist who will push the committee’s other voting members to ease monetary policy; however, if outvoted, the consequent dissension would put an unprecedented dent in the Fed’s credibility.
The more immediate concern for investors, however, is the artificial intelligence (AI) bubble.
Only a month ago, researchers Julien Garran, Andrew Lees, and James Ferguson, writing for MacroStrategy Partnership, argued the AI bubble, driven primarily by investments in Large Language Models (LLMs), represents the largest and most dangerous speculative mania in history. Citing the most significant misallocation of capital ever, they assert that LLMs lack genuine commercial value, regurgitate facts or buggy code without scalability or profitability, and that the entire AI ecosystem is sustained by hype, monopoly rents, and Nvidia’s unprecedented “round-tripping” investments, which are propping the market up to permit insider selling.
Garran et. al., present three main arguments including that extraordinary financial stimulus and the enabling of monopoly power have encouraged wasteful investments in AI, that AI’s inherent limitations and waning corporate adoption means AI returns won’t live up to the hype, and finally, the bubble’s unprecedented scale and the aftermath of its implosion will produce trillions in asset impairments, consequent economic malaise, and even a geopolitical rebalancing.
As the bubble bursts, it risks severe economic disruption, including reflation, inflation, and a shift toward emerging markets like India, while undermining the post-1979 global economic order.
Their report adds to the recent work of the U.S.-based St James Investment Company, which outlined the unrealistic economics required to justify the present investment wave in AI infrastructure. St James argues that if Morgan Stanley’s predicted AI spending of US$3 trillion by 2028 (excluding energy costs!), and McKinsey’s forecast of US$5.1 trillion by 2030, are reached, the revenues required to be spent by global AI users to generate a 20 per cent margin, and the free cash flow required to cover the cost of capital, would be US$3.1 trillion per year or 10 per cent of U.S. gross domestic product (GDP). This US$3.1 trillion users are required to spend on AI tools in 2028, compares starkly to the world’s current total spending of US$90 billion on Microsoft Windows and Office 365 annually. In other words, a 30x lift in just two years’ time is required to justify today’s AI infrastructure spend.
St James and Macro Strategy conclude that Large Language Models (LLMs) fail the profitability test. They variously argue that corporate adoption is already rolling over and that we are, therefore, living amid the greatest misallocation of capital and the biggest stock market bubble ever.
Macro Strategy goes further, arguing the then Magnificent 7 (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) market cap of US$10 trillion on forward earnings is inflated by AI hype. By stripping out loss-making LLM business units and the artificially extended chip depreciation rates, price-to-earnings (P/E) multiples collapse. They remind investors that the Nasdaq fell 78 per cent in 2000, when DotCom promises evaporated, and point out today’s concentration risk is larger.
I would add that Nvidia’s “round-tripping’ – ploughing profits into startups that buy its chips – is akin to the Australian furniture retailer, Nick Scali, or appliance retailer JB Hi-Fi, vendor financing the sale of houses to their customers, who in turn, fill them with Scali’s furniture and JB Hi-Fi’s appliances. Clearly, if correct, this produces unsustainable and ultimately undesirable returns for investors in Nick Scali and JB Hi-Fi.
What should investors do?
I think it’s relatively simple. Rebalance. I could be wrong. St James could be wrong. Macro Strategy could be wrong. It’s not a question of being all-in or all-out. But after three very solid, double-digit years in equities, it makes sense to reallocate at least some of the gains in equities to other asset classes in your portfolio. But which ones?
Today, there are several options available that are not only defensive in character but also offer truly attractive track records and uncorrelated returns.
One is a judiciously-selected private credit fund with an externally-AA-rated portfolio of thousands of short-duration loans spread across the entire economy of Australian industrial sectors that has produced more than seven per cent per annum over the last two years without a single month of negative returns to the unit price. Another is a wholesale private credit fund with a similar portfolio profile, externally rated BBB- and has produced more than nine per cent per annum over eight years without a single month of negative returns to the unit price.
A third option could be a High-Frequency Trading (HFT) digital asset arbitrage fund that has been running for four years, has produced more the 20 per cent per annum, and has experienced one negative month in those four years. Again, the returns aren’t dependent on the direction of the underlying securities. If digital currencies take off or tank, it shouldn’t matter to returns. What’s required is volatility. Arbitrage funds profit from simultaneously buying and selling the same instrument on different exchanges.
These funds have zero correlation to stock market returns, so if St James and Macro Strategy are right in their assessment, and the stock market corrects, these funds should prove defensive. And the High-Frequency Trading (HFT) Digital Asset fund benefits from greater volatility. They are ‘alternative’ funds, which means they aren’t supposed to dominate a portfolio, so be sure to have a detailed conversation with your adviser, challenging them if they broadly dismiss such options out of hand.
And of course, remembering we could be wrong, it may also be wise to consider rebalancing away from overpriced large-cap equities to more attractively valued small caps. Here it’s important to consider an actively managed fund because small caps are all about the people running them, whom small cap fundies keep in regular contact with.
This article was first published in The Australian on 05 November 2025.
For more information on the funds that Montgomery Investment Management offers, give David Buckland or Rhodri Taylor a call on (02) 8046 5000.
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The Polen Capital Global Growth Fund own shares in Nvidia, Alphabet, Microsoft and Amazon. This article was prepared 05 November with the information we have today, and our view may change. It does not constitute formal advice or professional investment advice. If you wish to trade these companies you should seek financial advice.
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Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
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