AI Stock Sell-Off Is Healthy Rotation, Not a Downturn, Says BofA

The recent sell-off in artificial intelligence-related stocks reflects a healthy market rotation and is not the beginning of a major downturn, according to an analysis from BofA Securities. The bank advises investors to diversify their portfolios amid elevated valuations and rising macroeconomic risks.

Drivers of the Pullback

BofA Securities attributed the weakness in the AI sector to several converging factors that have weighed on investor sentiment. The bank noted that the rally had led to crowded positioning in high-valuation, high-beta stocks, making them susceptible to a reversal.

Specific concerns contributing to the sell-off include:

• Questions about the sustainability of AI-driven data center spending.
• Rising costs for memory chips and AI tokens.
• A potential shift toward cheaper, open-source AI models from China.
• Seasonal trends, as momentum stocks often weaken between late June and early August.

Macroeconomic Shifts Prompt Rotation

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The broader economic environment has also encouraged investors to look beyond AI, BofA said. Falling crude oil prices and higher U.S. real interest rates have prompted a rotation into other sectors, a shift that may be masked by the performance of major benchmark indexes.

The bank identified a sustained spike in oil prices as the biggest risk to the market. Such a scenario could force the Federal Reserve to maintain a hawkish monetary policy, pushing real interest rates higher and triggering a more severe sell-off in richly valued AI stocks. However, BofA analysts believe this outcome is unlikely for now.

Outlook and Investor Strategy

BofA recommends that investors continue to hold AI-related positions but should also broaden their exposure to other industries. The bank warned that only an extreme rise in market concentration, similar to the dot-com bubble or the 2008 financial crisis, would signal a more serious breakdown.

While AI stocks could see a gradual rebound following first-quarter earnings, the recovery is not expected to be immediate. BofA advised investors to avoid stocks with excessively stretched price-to-earnings multiples and increase allocations to stable-growth companies and non-AI sectors like banks, defense, real estate, and retail, which could benefit from improving market breadth.