How to prepare for an AI stock market tumble

The big question in markets is simple: what next for stocks that have surged on the euphoria of artificial intelligence breakthroughs? And how might this affect the broader direction of world stock markets?

Results for Nvidia, the pioneering maker of microchips that are driving the AI revolution, on Wednesday night were the latest bellwether. Its shares had gained 35% so far in 2025 ahead of the update. Despite solid results, the stock fell 3% in after-hours trading. Uncertainty remains over sales of Nvidia’s AI chips in China. The company reached an unusual deal with the US government to share 15% of revenue from sales in China but the sales impact is unclear. Bloomberg called it a ‘tepid’ revenue forecast. 

Nvidia is the poster child for the AI revolution but many other of the world’s biggest companies have rallied on AI hopes — and possibly hype. Many are members of the ‘Magnificent Seven’ (Mag 7) club. Some are succeeding in developing powerful generative AI tools, capable of creating original content such as text, images, music, and code.

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Microsoft, owner of generative AI tools ChatGPT and Co-pilot, has seen its shares rise 20% this year. Facebook-owner Meta, with shares up 28% in 2025, is deploying AI to transform its ad revenues. Amazon has Inferentia and Trainium processors and is using AI in its cloud computing operation. It shares are only up 4% this year, largely due to the impact of tariffs on the ecommerce side of the business. Apple is behind peers on generative AI, though it has recently announced Apple Intelligence. It’s worth noting that AI infrastructure company Broadcom is now the world’s sixth largest stock.

The rally in these stocks has left many on historically high valuations. Nvidia, for example, trades on a forward 2025 price/earnings ratio of 42, according to Factset data.

Investors should first consider their exposure to the Mag 7 and to Nvidia, the world’s most valuable company. Nvidia made up 5.7% of the MSCI World Index — the basis for many global tracker funds — as of 31 July.

Top 10 constituents for the MSCI World Index

Source: MSCI - MSCI World Index 31 July, 2025

How to check your exposure to AI companies

The Fidelity Portfolio X-Ray tool gives a breakdown of your own exposure to each stock and fund. To use it:

1. Log in on a desktop.
2. Click on ‘account holdings report’ via the tab within your account summary page.
3. Select a benchmark to compare your portfolio against (e.g. ‘UK Large Cap Equity’ or ‘S&P 500’).
4. On the analysis report page, click ‘Export’ (top right) to generate the full X-Ray report.

Of course, other companies less directly involved with AI are also benefiting from productivity gains. But here, the focus is your direct exposure — and the question: are you comfortable with it?

Bull points

As my colleague Ed Monk summed up in The Times at the weekend: ‘Few doubt that AI will revolutionise many aspects of daily life, but that doesn’t mean we know exactly how, and when, that change will play out.’

Here, we set out some of the bull points:

• AI will revolutionise daily life and reshape the future of work, with potential to boost productivity and efficiency across industries. Earlier this month, Morgan Stanley estimated that AI adoption could deliver $920 billion a year in benefits, creating $13–16 trillion in value for S&P 500 companies.
• Valuations, while high, are lower than for stock market bubbles of the past, particularly the dotcom boom of 1999-2000.
• Earnings for Nvidia, Broadcom and peers are forecast to grow at a pace that justifies the higher valuations, driven by surging demand for advanced chips and cloud infrastructure.

Bear points

• AI stocks are overvalued. Jeremy Grantham, co-founder of the contrarian investment house GMO, says AI is a ‘bubble within a bubble’; he built his reputation for issuing warnings ahead of the dotcom crash, Even Sam Altman, founder of OpenAI, has warned that investors are ‘overexcited’ and many are likely to ‘get burnt’.
• The broader benefits from AI are overplayed. Last week, research from MIT (Massachusetts Institute of Technology) found 95% of AI corporate initiatives had delivered little or no financial benefit so far, highlighting uncertainty about commercial impact.
• Regulatory risks remain. Governments and regulators could curb AI progress if certain developments are viewed as detrimental to society.

What are the comparisons with the past?

The obvious comparison with today’s AI rally is the dotcom boom. Investors piled into a narrow set of companies promising to reinvent the world. Many were loss-making, built on hope rather than cashflow. When the bubble burst, the Nasdaq lost three-quarters of its value. Yet Amazon and Google survived and thrived — proof the long-term trend was real, even if early valuations weren’t.

One key difference today is valuations. Nvidia trades on a forward price/earnings (P/E) of 42, supported by robust profitability and demand for its AI chips. By contrast, Cisco during the 2000 bubble had a P/E of 201 at the peak.¹

Another parallel is the ‘Nifty Fifty’ — the supposedly ‘can’t lose’ blue-chips of the 1970s. Investors assumed you could pay any price for companies like Coca-Cola or IBM. They were right about the companies’ quality, but wrong about the prices. For a decade, those shares went largely nowhere. The railroad boom and bust of the Victorian era is also often cited.

AI is likely to be as transformative as the internet, the computer, trains or even electricity. The question is not whether it matters, but whether today’s winners justify their share prices. History suggests that in every great innovation cycle, investors get carried away.

Which stock market sectors might benefit if AI enthusiasm faltered?

If the froth comes off AI, investors may rediscover the virtues of dependable sectors.

• Consumer staples and utilities deliver earnings in good times and bad.
• Healthcare has demographic tailwinds and trades on relatively low valuations.
• Energy and financials could revive, offering strong cashflow, value, and dividends.

Simple ways to reduce AI exposure

One option for reducing your exposure to AI, if you believe that is right for you, is to switch some money from a standard global tracker fund to an ‘equal-weighted’ fund. Most passive money sits in funds based on market capitalisation. With this approach, the Vanguard S&P 500 ETF is 8% invested in Nvidia, it’s largest holding, followed by Microsoft at 7.4%.

But a new breed of tracker fund spreads money evenly between each company in scope. Legal & General S&P 500 US Equal Weight Index is one such fund. It was added to our Select 50 list earlier this year to give AI-concerned investors a sensible way to derisk their exposure. Note that the S&P 500 is on a P/E ratio of 24 compared to just 18 for the cheaper equal-weighted US index, according to data provider Factset (26 August 2025). 

Another option is to increase smaller company exposure. These companies will have less reliance on AI hype and are an area that has been neglected by investors for a sustained period. The Brown Advisory US Smaller Companies fund seeks out quality growth from below-the-radar names.

Alternatively, value investing is a natural way to avoid more expensive areas, such as AI. The Dodge & Cox Worldwide US Stock fund has a good track record and its holdings may find more favour when AI hype fades. Top holdings include financials Charles Schwab and MetLife, and aerospace and defence company RTX.

Given America’s pivotal role in the AI boom, a simple change is to upweight exposure to the UK and Europe. The Fidelity Global Dividend fund, also from our Select 50, only has 27% exposure to the US, around half what you would get with a global tracker fund. It has retained decent relative performance in recent years despite eschewing Mag 7 stocks. Top holdings include UK consumer goods group Unilever, Taiwanese chipmaker TSMC, Britain’s National Grid and American fund group BlackRock.

Or you could simply weight towards UK or European stock markets by buying funds focused on those areas. Passive funds to consider are the iShares Core FTSE ETF or Vanguard FTSE 250 ETF for the UK or Vanguard FTSE Developed Europe ex-UK for Europe. Among actively managed funds, Schroder European Recovery is very value focused and is particularly weighted toward banks, including Dutch banks ABN Amro and ING and BNP Paribas and Société Générale of France. By definition, value funds eschew highly valued parts of the market and so offer a good starting point for fund research amid frothy markets.

‘Sleep at night’ funds

It is worth highlighting funds that target smoother returns. These may appeal to those most concerned about current market valuations. They often have names such as ‘total return’, ‘absolute return’ or ‘multi-asset’ and can be found in fund sectors such as ‘flexible investment’ or ‘mixed investment’. They are sometimes known as ‘wealth preservation’ funds. Our full report - The sleep at night investment funds - explains more.

The other option is to shift some money into cash, although it is worth considering that returns over for the very long-term tend to be lower. Cash funds are a nimble way to move in and out of cash. The Legal & General Cash Trust is on our Select 50 list. It shows a distribution yield of 4.3%. This yield is not guaranteed and is likely to fall if interest rates continue to come down. Find out more about cash funds.

• Read: How far will interest rates fall?

And finally…

If you have doubts or concerns about making changes to your portfolio or your long-term financial plan, it may be that you need financial advice. Find out more about financial advice.

Source:

¹ Financial Times, 8.3.21

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