Lots of victim blaming and downplaying in this thread. That just perpetuates racism. Another thing is that a stereotype doesn't need to be negative to be hurtful -- it's all about erasing your individuality and reducing you to a caricature of yourself.
I agree 100% with @
STB Shujinkydink here. You'd be surprised how something as simple as "wow that's racist" can flip the direction of a conversation. Or if you want to be more aggressive, just say it to the women you're with (loud and in front of him so he knows you're talking about him); something like, "wow I didn't know you all hung out with racists." I usually go for sarcastic humor, so I might have said something like, "you didn't tell me we were going to a Klan meeting."
If he tries to negate his attacks by going in for hugs or whatever, just back up and say "no man, that's really messed up [not cool, whatever you'd normally say, etc.]." Force him to acknowledge that he was saying racist things. For me, the embarrassment and discomfort would make him feel worse than any punch I could throw.
Just make sure that whatever you do fits your personality. If you're not an aggressive dude, don't try to fight him. If you're not quick-witted, don't try to be clever. Hope that helps and makes sense.
P.S. if the people around you were laughing at this situation, it's usually uncomfortable laughter, not laughter due to being impressed or humored. Don't worry about what others are doing when you're in the moment, because most of the time people are just trying to keep the peace and move on as fast as possible.
