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JPMorgan strategist David Kelly says a series of extreme divergences in markets and the economy are putting the stock-market rally at risk.
For investors, “the average path forward looks comforting, if boring, and capable of supporting further gains in financial assets,” Kelly wrote in a note to clients on June 1.
“However, it is an average built of such divergent trends that there is considerable danger of ‘something’ going badly wrong from an economic, political or technological threat,” he continued. “In such an environment, it is impossible to be sure what that most likely ‘something’ could be and so it is very difficult to hedge against it.”
Kelly pointed out some major tail risks he sees, starting with income and wealth inequality in the US, which has steadily increased since 1980. One risk this could create for stocks is that it could lead to a left-leaning government taking power in both Congress in 2027 and the White House in 2029, he said, which could mean higher taxes on corporations, hurting earnings.
Second, wealth relative to income has grown to historically high levels also seen before prior stock-market crashes. The total value of household assets is now around 630% of GDP, up from 486% at the dot-com peak in 2000 and 435% before the 1987 decline. This is another variation on Warren Buffett’s favorite stock valuation measure of market capitalization relative to GDP, which he uses to spot episodes of excess in the stock market.
Third, tech stocks, particularly the biggest names in the sector, now make up a huge portion of the stock-market’s capitalization. The top 10 stocks in the S&P 500 make up 41% of the index, he said, and eight of them are in the tech sector. That makes the broader market potentially vulnerable to a pullback if the AI trade were to go sour.
And fourth, consumers are unhappy despite stocks hovering near records. Last month’s University of Michigan consumer sentiment survey reading hit a record low.
On top of all of that, stock valuations are stretched. The S&P 500’s 12-month forward price-to-earnings ratio is at 25, while its Shiller CAPE ratio — which looks at current prices relative to a 10-year rolling average of earnings — is at 39, approaching dot-com era peaks.
“If you pay at very exorbitant valuations, then you’re asking for trouble,” Kelly told Business Insider.
4 ways to hedge the risks
Kelly said broad diversification in investment portfolios is “more urgent than ever.” In an interview with Business Insider, he highlighted a few concrete ways that investors can achieve diversification.
First, he said he’d look to invest in developed market stocks, specifically in Europe and Japan. That’s because they have little exposure to the AI trade, whereas emerging-market funds tend to be tilted toward countries like Korea and Taiwan, which are heavily weighted in AI stocks.
“Today, people think that they are diversifying their US equity exposure by passively going into emerging markets, but if you actually look at what’s driving the EM indices, it’s the same stuff,” he said. “It’s basically a technology bet all over again.”
Second, he’d look to alternatives like, global transportation infrastructure and real estate, which offer an income stream that is uncorrelated to stock returns.
Third, value stocks offer a diversification opportunity as major indexes are now growth-heavy. In the same vein, Kelly said to look beyond the largest 10 stocks in the S&P 500.
Finally, Kelly said 10-year Treasury yields at about 4.5% are an attractive diversifier.
“For much of the last few decades, I would have said interest rates are so low that you ought to be underweight bonds,” he said. “I wouldn’t say that anymore.”
Examples of funds that offer exposure to these trades include the iShares MSCI Japan ETF (EWJ); the iShares Europe ETF (IEV); the SPDR Dow Jones Global Real Estate ETF (RWO); the Dimensional US Large Cap Value ETF (DFLV); the Invesco S&P 500 Equal Weight ETF (RSP); and the iShares 7-10 Year Treasury Bond ETF (IEF).
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William Edwards is a senior investing reporter at Business Insider primarily covering the US stock market and the broader economy.He’s interviewed some of the most influential voices in the market, including Joseph Stiglitz, Jeremy Grantham, Rick Rieder, Rob Arnott, Savita Subramanian, Nouriel Roubini, Ken Rogoff, Mike Wilson, Claudia Sahm, Albert Edwards, Andrew Ross Sorkin, and more.William launched BI’s annual Oracles of Wall Street list (2023, 2024, 2025), highlighting top calls from strategists, economists, and analysts. He also writes BI’s Where to Invest $10,000 column, and contributes to the First Trade newsletter.Prior to Business Insider, William covered the US economy for Bloomberg News in Washington, DC and contributed to TV tech coverage for CNBC in San Francisco. He has also spent time studying or reporting in France, Germany, and Tunisia.He is based in New York.
