Should I stay, or should I go?

If I go, there will be trouble

And if I stay, it will be double

So come on and let me know

Should I stay or should I go? —The Clash

During the latter part of 2025, one of the most common topics in conversations with clients was whether markets are in a

bubble

, particularly with respect to

AI

-related companies.

Nobody can know for certain whether such a bubble exists, let alone how and when that story will end. However, analyzing the current environment from a risk-reward standpoint can provide investors with a useful framework to consider their current portfolio allocations and to determine whether changes are warranted.

Between a rock and a hard place: Loss versus opportunity cost

All bubbles eventually burst and leave a wake of losses when they do. However, in instances of false alarm where suspicions of a bubble prove unfounded, those who run for the hills suffer the opportunity cost of leaving significant sums of money on the table.

It is similarly challenging to navigate true bubbles, as they have a tendency to grow much bigger and to persist far longer than what may seem possible (one need look no further than Japanese stocks in the 1980s or tech stocks in the late 1990s). Although losses do eventually materialize, this does not change the fact that stepping aside before the comeuppance can result in forgone gains as prices continue to rise long after alarm bells begin ringing.

That being said, opportunity cost is not merely the returns on the investments you forsake, but rather how those missed returns compare to those of the assets for which you forsake them. Alternately stated, it’s not just about the returns you’re missing, but rather about the returns you’re missing versus the returns you’re getting in their stead.

Not all bubbles are created equal: A trip down bad memory lanes

Historically, different bubbles have been accompanied by different investment environments, thereby presenting investors with vastly different prospective risks and returns. Some bubbles occur in environments that are far more ominous than others. Relatedly, the prospective opportunity costs of avoiding them can be vastly different. More specifically, the greater the potential returns are for non-bubble assets, the lower the associated opportunity costs of avoiding the bubble.

The dot-com bubble (2000-2003): Attractive alternatives aplenty

In early 2000, U.S. large-cap stocks stood at their highest valuations in modern history. Between the summer of 2000 and the spring of 2003, the S&P 500 index declined by 45 per cent in inflation-adjusted terms, while the tech-oriented Nasdaq Composite index fell 79 per cent. Given the historically inverse relationship between valuations and future returns, this ugly aftermath should have come as no surprise.

However, these losses were largely avoidable while simultaneously achieving reasonable returns elsewhere.

Emerging market

equities, emerging market bonds and Real Estate Investment Trusts (

REITs

) exhibited valuations that suggested decent returns over the medium-term. In addition, Treasury Inflation-Protected Securities (TIPS) and cash were yielding four per cent and two per cent above

inflation

, respectively. Investors who were willing to reallocate based on relative valuations were not forced to endure meaningfully subpar returns by avoiding what appeared to be (and were subsequently proven to be) overvalued assets.

The everything bubble (2007-2008): Nowhere to hide except bonds

The “everything bubble” of 2007-2008 was an entirely different animal. By the time the good times had peaked in 2007, practically all equity markets had become overpriced, foreshadowing negative returns over the next several years regardless of country or region.

Only safe harbour assets such as TIPS, government bonds and cash offered positive, albeit meagre returns. The only way to avoid significant losses was to liquidate all risky assets, hide in safe assets and accept lacklustre, albeit positive, returns.

The duration bubble (2021): Nowhere to hide

The duration bubble of 2021 bore a far greater resemblance to its 2007-2008 predecessor than to the dot-com bubble, albeit even more problematic.

At the end of 2021, U.S. stocks were far from alone in terms of their elevated valuations. As such, equities in nearly every region had negative expected returns over the next few years. Further complicating matters, government bonds were also grossly overvalued and thus could not be construed as a safe harbour.

In essence, investors were stuck between the “rock” of overvalued equities and the “hard place” of bond yields that stood substantially below inflation levels. Even cash, which was the only asset that didn’t suffer losses, failed to keep pace with inflation.

Artificial Intelligence: If it’s a bubble, it’s of the better variety

The exceptional performance of mega-cap, AI-related stocks has propelled the S&P 500 to a cyclically adjusted valuation that stands above its 2021 peak and is only 10 per cent below its all time high prior to the dot-com crash.

Fortunately, as was the case in late 1999 to early 2000, there are plenty of other games in town. Both international developed and emerging market equities are valued at levels that suggest attractive returns for the foreseeable future, while REITs offer returns that, while lower, are nonetheless comfortably above inflation.

For those with balanced portfolios, both U.S. and emerging market bonds currently offer yields that are healthily positive on a net-of-inflation basis. As such, there are many places where investors can reallocate away from U.S. stocks, mitigate the risk of severe losses, and still expect to achieve reasonable returns over the next several years.

While an AI-led crash in U.S. stocks is by no means imminent or guaranteed, it seems unlikely that they will perform as strongly as they have over the past several years. When juxtaposed against the reasonable valuations and expected returns of other assets, this suggests that there is limited risk associated with rebalancing away from AI-related companies and U.S. large-cap stocks in general.

  • The two most powerful forces in stock markets are chasing each other
  • Bonds are key to cushioning stock losses in bear markets. But here’s why it’s not so simple

Noah Solomon is chief investment officer at Outcome Metric Asset Management LP.

_____________________________________________________________

If you like this story,
sign up for
the FP Investor Newsletter.