When investors think about protecting their money during a market crash, bonds often seem like the safe choice—kind of like grabbing an umbrella when storm clouds gather. But what if that umbrella has holes in it? The coming AI crash might punch right through traditional bond protection in ways many investors don’t expect.
Rising interest rates create a nasty surprise for bond holders. When rates go up, bond prices fall like a rock thrown into a pond. This inverse relationship means fixed income securities lose value just when investors need safety most. Long-duration bonds get hit especially hard, experiencing wild price swings that can make a roller coaster look tame.
When interest rates climb, bonds tumble like stones—turning your safety net into a financial free fall.
The real kicker comes during market stress when correlations break down completely. Historically, stocks and bonds moved in different directions, providing that comforting diversification. But severe market events tend to scramble this relationship like eggs in a hot pan. During past financial crises, both stocks and bonds often fell together, leaving investors with nowhere to hide.
Credit markets add another layer of risk that many overlook. When an AI bubble bursts, credit spreads widen dramatically. High-yield bonds face increased default risk while investment-grade bonds suffer downgrades. Even supposedly safe bonds can lose significant value as credit conditions deteriorate across the board.
Inflation presents yet another threat to bond portfolios. When prices rise faster than bond coupon payments, investors actually lose purchasing power. It’s like running on a treadmill that keeps speeding up—you work harder but go nowhere. Many investors turn to index funds for their retirement accounts precisely because they offer more predictable returns during uncertain times.
The AI crash might be different from previous bubbles in one important way. Current AI spending relies mostly on companies’ own cash rather than borrowed money. This internal financing reduces the systemic risk seen in debt-fueled bubbles like fiber-optics or gas turbines. Estimates suggest a 12-15% correction rather than a devastating 40% crash. Smart investors are already building dry powder positions to take advantage of buying opportunities during the inevitable downturn.
Still, concentration risk looms large. The top five S&P 500 companies control about 30% of the index weight, mostly in AI-related businesses. Without a clear strategy for managing this concentration, investors may find their bond allocations insufficient protection during an AI correction. This concentration means even bond-heavy portfolios might not escape the AI correction as cleanly as investors hope.
