Investing.com -- The equity rally fueled by artificial intelligence enthusiasm may be entering a more vulnerable phase, according to Barclays analysts in a note on Tuesday.

The bank warned that signs of investor euphoria, crowded positioning and rising interest-rate risks are beginning to accumulate.

Barclays analyst Stefano Pascale told investors that the recent market advance has been driven by a combination of “strong earnings, AI optimism, positioning catch-up, and options-led upside chasing.”

While Pascale remains constructive on the longer-term outlook, he believes the risk of a near-term pullback is increasing.

“Positioning is now stretched,” he stated, pointing to heavy inflows and fragile systematic exposure. The bank also noted that markets have become increasingly sensitive to interest rates as investors adjust to a “more persistent inflation/higher neutral rate outlook.”

At the same time, sentiment indicators suggest growing exuberance. Barclays stated that “euphoria has rebounded vigorously,” while volatility has fallen and option-market pricing has made downside protection more attractive.

Despite these concerns, the bank acknowledged that markets currently lack a clear catalyst for a correction. That combination of rising vulnerabilities and steadily advancing equity prices creates what Barclays described as a “strike drift” risk for traditional hedging strategies.

As a result, Barclays favors lookback put options, arguing they allow investors to “lock in high-water marks and reduce timing risk.” The bank said historical analysis indicates such structures can provide a better risk-reward profile than standard put options.

The bank also highlighted opportunities in equity-rate hybrid hedges, particularly strategies designed to benefit from a simultaneous decline in equities and rise in bond yields.