Bank of America Hartnett: Key indicators show that AI is not yet at risk, beware of the impact of a dollar rebound on popular trades

Is the AI bubble market over? Bank of America believes it has not yet reached "dangerous levels," and the real risk in the market currently lies in the rebound of the dollar.

Despite the growing discussion about a potential bubble, Bank of America strategist Michael Hartnett pointed out in his latest report that the credit spread of tech stocks is at a multi-year low, which means that the AI-driven rally in tech stocks has not yet reached dangerous levels.

Hartnett further warned that the immediate risk investors need to be wary of is not a bubble burst, but rather an unexpected strengthening of the dollar. The current market's biggest vulnerability is the consensus trade of "shorting the dollar." Once the dollar index experiences a "disorderly" rebound and breaks above the key level of 102, it could trigger a collective unwinding of "risk aversion."

Nevertheless, Hartnett believes that in the 2020s, characterized by rising inflation and interest rates, large-scale government debt and ongoing currency depreciation remain long-term trends. This means that while there is a short-term risk of a dollar rebound, the fundamental basis for its long-term depreciation has not changed, which is also why assets like gold have structural support.

Credit spreads indicate that AI has not formed a credit bubble

Regarding the market's widespread concerns about the AI bubble, Hartnett believes that "a complete collapse is unlikely," as the current credit spreads of tech stocks are at their lowest point in 18 years.

Credit spreads measure the additional yield of corporate bonds relative to risk-free government bonds, and a narrowing spread typically indicates that the market perceives a low risk of default for issuing companies.

The report emphasizes that the current credit spreads of tech stocks are at historical lows, indicating that investors are not pricing in the potential risks of tech companies in the credit market, which sharply contrasts with the typical late-stage of an asset bubble (usually accompanied by a sharp rise in credit risk).

This means that from the perspective of the credit market, the AI-driven tech boom has not yet evolved into a dangerous credit bubble.

The latest EPFR fund flow data further confirms investors' optimistic sentiment. The data shows that last week, global funds continued to flow into various assets: $24.7 billion flowed into bond funds, $21.3 billion into cash, $19.6 billion into stocks, $5.6 billion into gold, and $600 million into cryptocurrencies.

This comprehensive inflow of funds indicates that despite discussions of a market pullback, investors overall have not retreated due to concerns about an imminent market collapse and are still actively allocating risk assets.

"Shorting the dollar" has become a consensus, beware of the risk of a dollar rebound

So far this year, gold has been the best-performing asset, with a year-to-date increase of 41.3%. In contrast, international stocks rose by 24.7%, Bitcoin by 17.7%, U.S. stocks by 12.3%, while the dollar index fell by 9.2%.

Hartnett analyzes that the continuous depreciation of the dollar is the core driving force behind the rise in asset prices this round. He pointed out that in the past 12 months, global central banks have cut interest rates 168 times, with the frequency of cuts only second to that during the global financial crisis and the COVID-19 pandemic. This has injected significant liquidity into the market, directly leading to a weakening of the dollar and driving substantial increases in assets such as gold, cryptocurrencies, and stocks.

This performance divergence clearly reflects the negative correlation between the weakening dollar and the strengthening of risk assets. Therefore, Hartnett believes that as long as the consensus trade of "shorting the dollar" is not disorderly reversed, the macro environment for asset appreciation will continue.

The report further warns that the biggest vulnerability in the current market is the consensus trade of "shorting the dollar." If the dollar index experiences a "disorderly" rebound and breaks above the key level of 102, it could trigger a collective unwinding of consensus trades, including steepening the yield curve, going long on global bank stocks, and going long on the Nasdaq index, in a "risk-off" manner.

Nevertheless, Hartnett believes that while there is a risk of a short-term rebound for the dollar, the long-term basis for its depreciation has not changed, which is also the reason why assets like gold have structural support.

Hartnett acknowledges that tactically, gold is currently in an "overbought" state. However, structurally, it remains a "underweight" asset. Data shows that gold accounts for only 0.4% of private client assets under management (AUM) and only 2.4% of institutional client assets under management.

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