"You can continue to enjoy the AI bull market," but Nomura warns: Now is not the time to abandon hedging.

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The latest analysis from Nomura Securities points out that although the AI-driven U.S. stock bull market remains fundamentally solid and investors can still participate, the market has accumulated significant downside risks. Abandoning hedging strategies at this point would be dangerous.

According to strategist Charlie McElligott, the current market is in the midst of an “AI-driven frenzy,” creating a virtuous cycle that is constantly pushing indexes to new all-time highs. This ongoing rally is forcing previously skeptical investors to chase and buy in, further fueling the surge.

However, McElligott warns that although hedging strategies may drag down short-term performance, investors “absolutely must not abandon hedges now.” He notes that the market faces significant “convexity to the downside” due to extreme net long positions, negative gamma, and potential volatility squeeze risks. If a catalyst emerges, declines will be exponentially magnified by negative gamma, high leverage, and crowded longs being forcibly unwound, creating an accelerating “waterfall” effect as prices fall faster.

Market dynamics also confirm this paradoxical situation. On one hand, option market skew has sharply dropped, with demand for calls rising significantly relative to protective puts, indicating strong bullish sentiment. On the other hand, technical indicators show systematic flows are ready for “asymmetric selling,” increasing the market’s vulnerability to corrections.

Multiple Tailwinds Behind the AI Frenzy Sustain the Bull Market

Nomura believes that the ongoing U.S. stock market bull run is supported by multiple factors. First, the Federal Reserve has shifted its policy focus from fighting inflation to monitoring the labor market, and its dovish turn has created an expectation of easing. Second, fiscal stimulus and large-scale deficit spending continue in the U.S. and globally.

Meanwhile, the wealth of high-income U.S. consumers remains strong, making them the main engine of consumption. A loose financial environment—including a weaker dollar, high portfolio values, attractive cash yields, very tight corporate credit spreads, and extreme compression of cross-asset volatility—also strongly supports the market. In addition, thanks to robust U.S. consumer activity, nominal GDP maintains a healthy level of around 5%, and corporate profits have shown remarkable resilience.

Among these, the “AI halo” effect—represented by large tech stocks—is the key theme driving market risk appetite. The strong cash flows of these companies are not only fueling rapid capital expenditures, but also financing unprecedented stock buybacks, serving as the ultimate source of equity demand and volatility supply.

Caution: Cyclical Investment Patterns Raise Concerns

Despite ample reasons for the bull market, McElligott also highlights some disturbing phenomena in the market. He mentions that recent collaboration announcements among tech giants reveal an increasingly risky cyclical “AI revenue/capex” model. In this setup, the giants are allocating tens of billions of dollars back and forth among one another, essentially recycling capital.

This situation in some ways parallels the “vendor financing” seen during the late stages of the dot-com bubble. However, McElligott points out two key differences: first, today’s capital recycling is mainly driven by cash rather than debt; second, unlike dot-com 1.0 firms which often lacked viable business models, today’s data centers are generating real revenues from real users. Nonetheless, he argues this mode should make the market a bit uneasy about the ongoing rally.

Market Sentiment Indicators: Investors Chasing Upside and Adding Leverage

The market has not paid attention to these lurking risks, but is instead once again chasing upside U.S. equity index options, giving rise to a “Spot Up, Vol Up” scenario where prices and volatility rise together. Data shows investors are increasing positions in high-beta, high-volatility, and heavily shorted stocks, while simultaneously adding leverage as indexes hit new record highs.

Activity in the options market is especially noteworthy. The SPX index options skew is “plunging off a cliff,” with demand for calls rising sharply relative to put hedges. Call skew has surged to its steepest level since the start of the year, signaling that investors are scrambling to buy upside protection for “continued market mania.” Meanwhile, puts (downside protection) are increasingly abandoned as rallying markets eat away at their value.

Why Hedging Strategies Are Crucial

The core of Nomura’s warning is that the technical structure of the market has become extremely fragile. Currently, the supply from various volatility selling strategies has led market makers to accumulate the largest long gamma exposures (at-the-money options) of the year. This has suppressed short-term volatility, creating a “slow grind up.”

However, the danger is that systematic flows are already “set up for asymmetric selling under a volatility squeeze.” Combined rebalancing and hedging demand from the options and leveraged ETF markets indicate that potential selling pressure approaches a 2:1 ratio with buying demand—posing major “deleveraging liquidity risks.”

To sum up, McElligott’s conclusion is clear: investors may continue to participate in this AI-driven bull market, but considering the market’s extreme positioning and potential for downside convexity, maintaining hedges is an essential risk management tool at this stage.

Risk Warning and DisclaimerMarkets are risky, and investing requires caution. This article does not constitute personal investment advice, nor does it account for any individual user’s specific investment goals, financial situation, or needs. Users should consider whether any opinions, views, or conclusions herein apply to their own circumstances. Investing based on this article is at your own risk. ```