Is the AI Rally Losing Steam? Investors Eye the ‘Other 493’
For three years, artificial intelligence has been the undisputed king of the stock market, fueling a remarkable 78% surge in US equities. But a growing chorus of investors believes this reign is nearing its end. Concerns are mounting that the transformative economic impact – and the accompanying profits – promised by AI may not materialize as quickly as hoped, leading to a shift in investment focus.
The Rise of ‘AI Fatigue’ and a Rotation to Value
“I call it ‘AI fatigue,’” says Ed Yardeni, president and chief investment strategist at Yardeni Research. “I’m tired of it and I suspect a lot of other people are sort of wary of the whole issue.” This sentiment is driving capital towards the “other” 493 companies within the S&P 500 – those that stand to benefit from broader economic growth, rather than being solely reliant on the AI narrative.
The dominance of the “Magnificent Seven” – Nvidia, Microsoft, Apple, Alphabet, Meta, Broadcom, and Oracle – has been unprecedented. Since 2022, when OpenAI’s ChatGPT captured the world’s attention, these tech giants have added trillions to their market capitalization. However, recent data suggests a subtle but significant shift. Since the S&P 500’s late-October peak, the Magnificent Seven have collectively fallen 2% while the S&P 493 has climbed 1.8%.
The XMAG ETF: A Gauge of the Shift
The launch of the Defiance Large Cap Ex-Magnificent Seven ETF (XMAG) at the end of 2023 provides a tangible example of this trend. The ETF experienced six consecutive months of inflows, culminating in a quadrupling of investment from November to December. XMAG rose 15% last year, with the majority of gains occurring in the latter half of the year.
Beyond Tech: Sectors Poised for Growth
If economic growth materializes, cyclical and growth-oriented sectors are expected to flourish. Financial institutions like JPMorgan Chase and Bank of America are well-positioned to benefit from improved economic conditions. Consumer discretionary stocks, such as Nike and Booking Holdings, could see increased demand as consumer confidence rises.
Interestingly, the S&P 493 demonstrated “impressive” performance in 2024, according to Yardeni. Profit margins for these companies remained robust despite headwinds like the establishment of the Department of Government Efficiency and President Trump’s tariff agenda.
Historical Precedents: The Nifty Fifty and the Dot-Com Bubble
However, history suggests that a shift away from dominant market leaders isn’t always smooth. Doug Peta, chief US investment strategist at BCA Research, points to the collapse of the “Nifty Fifty” in 1973 and the bursting of the dot-com bubble in 2000 as cautionary tales. In both instances, the broader market experienced a pullback when its previously high-flying leaders stumbled.
Peta believes the AI trade still has potential, but warns that investors are becoming more discerning. The initial “monolithic” approach – where any company associated with AI saw its stock price rise – has fragmented, with even previously favored AI stocks like Oracle experiencing losses.
Goldman Sachs’ Outlook: A Gradual Shift
Goldman Sachs strategists echo this sentiment, predicting that the Magnificent Seven’s contribution to S&P 500 earnings growth will decrease from 50% in 2024 to 46% in 2026. Simultaneously, they anticipate an acceleration in earnings growth for the S&P 493, rising from 7% in 2025 to 9% in 2026.
Value and Macroeconomic Factors
The S&P 493 is also attracting investors seeking value. Goldman Sachs highlights favorable macroeconomic conditions and wide valuation spreads as positive indicators. Their recommendations include overweighting positions in healthcare, materials, consumer discretionary, and software & services.
Navigating the Transition: Risks and Opportunities
While a shift away from the Magnificent Seven could unlock opportunities in other sectors, it’s unlikely to be without turbulence. Peta suggests that a “peaceful transfer of power” to the broader market is unlikely, and a meaningful bear market may be necessary before new leadership emerges.
FAQ: The Future of AI Investing
- Is the AI bubble bursting? Not necessarily, but investor enthusiasm is cooling, and a more selective approach is emerging.
- What sectors should I consider? Financials, consumer discretionary, healthcare, materials, and software & services are all poised for potential growth.
- Should I sell my AI stocks? That depends on your individual investment strategy and risk tolerance. Consider diversifying your portfolio.
- What is the XMAG ETF? It’s an ETF designed to track the performance of the S&P 500 excluding the Magnificent Seven.
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