AI trade concentration makes diversification elusive, J.P. Morgan strategist warns

True diversification away from the artificial intelligence (AI) trade has become difficult to achieve, according to Gabriela Santos, chief market strategist for the Americas at J.P. Morgan Asset Management.

Santos, speaking on CNBC's "Closing Bell Overtime," noted that the scale of AI capital expenditure has expanded to the point where its impact spans virtually all asset classes, including equities, fixed income, and private markets.

Lessons from a Difficult Summer

According to Santos, the momentum reversal during the summer struck AI-related stocks the most severely in July, with the effect persisting into August. This event highlighted an important takeaway for investors optimistic about AI.

"You can be really really bullish AI and still need to think really really carefully about portfolio construction."

This, she explained, requires greater focus on position sizing, leverage, and diversification – even for those who believe AI will continue to fuel an extended earnings cycle.

Santos further noted that the AI buildout is constantly evolving, rendering traditional sector classifications less dependable. Hyperscalers, chip manufacturers, and software firms are increasingly showing divergence within their own sectors, instead of trading in unison.

This worry mirrors cautions from other parts of Wall Street. A well-known investor recently remarked that the market now functions as a single AI trade.

Areas Where Diversification Remains Possible

J.P. Morgan created an AI factor basket to assess the degree to which assets and portfolios align with the broader AI trade. According to Santos, the findings indicate that most assets are now moving in tandem.

True diversification is largely confined to treasuries, gold, core real estate, and European equities. This lack of options recalls recent alerts about a wider collapse in stock-bond diversification.

In the past, bonds consistently provided a buffer for portfolios during recessions. In the two decades following the financial crisis, low yields meant that bonds alone were sufficient.

But Santos stated that this dynamic has shifted. Competition for capital has resurfaced, accompanied by supply shocks, inflation, and rate volatility. She added that investors now require additional assets that are resistant to inflation to complete their portfolio positioning.

The sustainability of that mix may hinge on how AI-related capital expenditure unfolds over the remainder of the year.