The new year has begun with a bang with global equities at, or near, record highs. But as fears of an artificial intelligence (AI) led bubble mount, reducing downside risk without necessarily sacrificing lots of upside potential makes increasing sense.
Read this article to understand:
- The dilemma for investors in the face of soaring US tech stocks
- Ways in which they might look to reduce exposure to a market correction
- Why allocating to defensive income-generating strategies might make sense
Many investors feel caught between bulls arguing sky-high valuations are merited by the AI’s revolutionary potential, and bears arguing this time is no different and that as with the dotcom mania of the late 1990s, the bubble will eventually deflate.
According to a recent survey of fund managers by Bank of America, while 42 per cent reported being “long” of the largest seven US tech companies, 33 per cent cited an AI bubble as the biggest “tail” risk, making it the group’s biggest concern (see Figure 1).
Figure 1: A worrying contradiction? (per cent)
For illustrative purposes only and not intended as an investment recommendation.
Note: Reprinted by permission. Copyright © 2026 Bank of America Corporation (“BAC”). The use of the above in no way implies that BAC or any of its affiliates endorses the views or interpretation or the use of such information or acts as any endorsement of the use of such information. The information is provided "as is" and none of BAC or any of its affiliates warrants the accuracy or completeness of the information.
Source: Aviva Investors, Bank of America Corporation. Data as of October 2025.
This apparent dichotomy reflects the acute dilemma facing equity investors following the surge in share prices: pull money out and miss out on a further big rally or stay invested and risk a painful collapse in valuations as the bubble bursts.
The dilemma appears all the more pronounced because traditional safe-havens such as gold and bonds have also been rising.
Bubble or not, what is undeniable is that many US tech valuations are at dizzying levels which are increasingly hard to justify as venture capitalists, investors and the biggest US companies pour trillions of dollars into developing artificial intelligence (AI). According to one recent FT report, ten loss-making AI start-ups had gained close to $1 trillion in valuation over the past year.
This has in turn driven concentration within the US stock market to unprecedented levels as shown in Figure 2. For each dollar invested in the US stock market, 38 cents now goes into just ten companies. Nine of these stocks are in the technology sector, if Tesla is included.
Figure 2: Big tech’s rising dominance of US market (per cent)
Source: Aviva Investors, Datastream. Data as of January 26, 2026.
The rally in tech shares has also left the US market exorbitantly valued both relative to peers and its own history as seen in Figure 3. This is not just a problem for those looking to gain exposure to US stocks, but for global investors too, as US shares account for a bigger slice of global indices than ever before.
Figure 3: US stands out as most expensive market
Note: Valuation versus 15-year median (per above or below).
Source: Aviva Investors, Bloomberg. Data as of January 26, 2026.
The importance of staying invested
There is a wealth of data that demonstrates the importance of investors maintaining a long-term perspective. For instance, the MSCI World index has returned 8.3 per cent per annum over the past 30 years, a period that included the dotcom bust, the global financial crisis and Covid. Over fifty years, the annual return rises to 9.9 per cent.
The longer the investment horizon, the greater the probability of avoiding losses
Moreover, the longer the investment horizon, the greater the probability of avoiding losses. Starting at any random point over the past 96 years, an investor would have made money over the following five years 87 per cent of the time. Over rolling ten-year periods that rises to 94 per cent and on every occasion over 20 years.
There is similarly strong evidence to support the idea investors should remain invested as timing the market with the necessary precision is exceedingly difficult, even for seasoned investors.
For instance, €10,000 invested in the S&P 500 in 1988 was worth €522,570 by the end of 2024. Missing out on just the five best days would have reduced that to €233,056. And missing out on the best 40 days would have slashed the final sum to €55,890.
Ways to find protection
However, powerful as these statistics are, there is no denying many investors, even in equities, are risk averse. With a sustained rise in share prices having strengthened their financial position, many will no doubt be looking for ways to protect their portfolio.
With virtually all asset prices having risen simultaneously, that is easier said than done. While some may be tempted to sell out and park the money in cash, there are limits to how much cash most investors will want to hold. That is especially true at a time when central banks are taking a risk with inflation by cutting interest rates.
Income investing tends to deliver comparatively stable returns
One option investors might want to consider is upping their exposure to more defensive income-generating strategies within their overall equity allocation.
Since it is easier to value a company paying a dividend than one which has yet to, income investing tends to deliver comparatively stable returns. Crucially, shares in mature dividend-paying businesses have historically outperformed during market sell-offs.
Done well, this strategy has the potential to offer investors significant downside protection without sacrificing too much upside. After all, dividends, and dividend growth, have historically been the most important drivers of total equity returns over the long term, as seen in Figure 4.
Figure 4: Total real equity returns (local currencies) over the past 30-years (per cent)
Past performance is not a reliable indicator of future performance.
Note: Rolling 10-year annualised real returns.
Source: Aviva Investors, Société Générale Research, Thomson Datastream. Data as of June 30, 2025.
Sectors being overlooked
In the clamour for the shares of companies growing earnings on the back of the AI boom, investors have tended to overlook many attractively priced shares in other sectors. That is true even in the US, where shares valuations look far less stretched after stripping out the technology sector.
Investors concerned about equity valuations and mindful of concentration risk can find plenty of attractively valued shares beyond the technology sector. For instance, consumer staples and healthcare are two traditionally defensive sectors which are presently trading as cheaply relative to the broader market as they have done for two decades or more.
Plenty of companies in each sector are growing cash flows and dividends
While there are some reasons for this, a closer look reveals plenty of companies in each sector that are growing cash flows and dividends, and that are well placed to continue doing so despite some challenges their broader sectors face.
The idea that AI will not benefit these sectors is arguably mistaken. Consumer staples companies spend large sums on advertising and promotional activity and AI has the potential to help them target customers far more accurately.
Likewise, pharmaceutical firms should see a material benefit from AI’s ability to optimise drug trials and shorten the time it takes to bring drugs to market, which in turn should enhance productivity when it comes to their significant research & development (R&D) spending.
It is impossible to know for sure if this is a bubble, yet. The rally could go on for a while longer. It is worth remembering the Nasdaq Composite index fell nearly 20 per cent in August 1998, but within 18 months had more than tripled in value.
But as the events of a quarter of a century ago showed, prices never rise for ever. If it has not already, it seems certain the present trend of dominance by a few large tech companies will eventually come to an end. Furthermore, when such rallies end, they don’t gradually deflate, they burst in spectacular fashion. If the dotcom bust is anything to go by, losers are likely to far outnumber winners.
As with the dotcom boom, there are likely to be some big winners from AI
As with the dotcom boom, there are likely to be some big winners from AI. And unlike that episode, many of the companies at the centre of today’s AI boom are hugely profitable, generating lots of cash, and have little debt.
Nonetheless, it would be understandable if many investors were growing concerned about equity markets’ ability to go on rising exponentially. While cashing in might be a valid option for some, such a strategy has big drawbacks for the vast majority, especially given the upside risks to inflation.
For these investors, a better option might be to adopt a more defensive slant for at least a portion of their equity portfolio. While all equities are likely to suffer in the event of a market collapse, income-focused strategies offer both growth potential and an element of downside protection that could be valuable.
