Technological revolution does not equal guaranteed stock market profits! Dalio offers advice for the AI bubble era

As the US stock market hits new highs, Bridgewater Associates founder Ray Dalio warns that the AI investment frenzy has already formed a bubble and the market is entering a phase of increasing risk. Facing economic and market uncertainties in the next two to four years, he advises investors to diversify their portfolios, include gold and inflation-protected bonds as part of their investments, and stay vigilant against overvalued AI leaders heavily reliant on debt financing.

Dalio stated in a podcast interview with financial journalist Julia LaRoche last week that investors must be aware of the risks present in the current market environment. He has repeatedly warned of an AI investment bubble and recently noted at the Forbes Global CEO Conference in Singapore that tech companies and investors are leveraging debt to boost their AI investments. With interest rates continuously rising, this wave could be approaching a breaking point.

AI Technological Revolution Does Not Equal Investment Returns

Dalio compared the current AI boom to the technological boom before the 1929 US stock market crash. He pointed out that major technological revolutions are often accompanied by high uncertainty and require massive capital input. Even though the technology itself is transformative, related stocks may experience sharp declines due to overpricing or excessive debt financing.

He believes investors tend to confuse the value created by technological progress with stock investment returns. A promising industry does not necessarily mean every company involved deserves to be bought at high valuations.

Dalio also wrote on social media last month that investors have previously chased influential new technologies like electrification, but if asset prices are too high or buying depends on significant borrowing, the market could replay the crash seen between 1929 and 1933.

He also emphasized that paper wealth does not equate to cash that can be freely disposed of. Investors can quickly accumulate nominal wealth through financing and borrowing, but if asset sales are required to realize gains, large-scale selloffs could become the spark that bursts the bubble.

The current market's fragility also stems from rising interest rates. US Treasury yields are at their highest levels in decades, pressing down bond prices, yet the S&P 500 and Nasdaq Composite have both recently hit record highs. Dalio believes higher rates will depress bond prices and add pressure to highly valued stocks; when balance sheets are loaded with debt, risks can be amplified.

Gold Allocation of 5% to 15%, Focus on Inflation-Protected Bonds

To address future uncertainties, Dalio suggests investors build more balanced and diversified portfolios. He proposes that gold allocation could range from 5% to 15%, citing gold as a hard currency that provides risk diversification in an environment of rising government debt.

However, gold is not without short-term pressures. Since the beginning of this year, rising bond yields and a stronger US dollar have both weighed on gold prices. As gold does not generate interest, the opportunity cost of holding gold also increases as yields rise.

Beyond gold, Dalio is also optimistic about inflation-protected US Treasury Bonds (TIPS), especially leveraged inflation-protected bonds that amplify exposure to inflation and interest rates. He noted that the expected return on cash is low, while the real yield on inflation-protected bonds is currently around 3%, making them attractive. He also expects that inflationary pressures will persist.

Avoid Expensive AI Giants, Seek Beneficiary Companies

For stock selection, Dalio believes investors should focus on companies capable of transforming their business through AI, such as those able to improve operations by boosting sales or reducing costs. He feels these companies may not yet be fully priced by the market.

As for the large tech companies currently leading the AI boom, he remains cautious. Dalio bluntly states that mega-scale cloud service providers and other heavy AI investors have over-inflated valuations and are expensive.

He predicts that the next two to four years will be highly risky, with political events like the US midterm elections in November and the 2028 presidential election further increasing market uncertainties.

"There are more things you don’t know than all you know about the future." Dalio stated that, in such an environment, balance and diversification in asset allocation are crucial.