Morgan Stanley: A.I. Hype Fades, Market Seeks New Catalyst

The artificial intelligence (AI) boom that propelled the S&P 500 to record highs this year is losing steam. Morgan Stanley’s Mike Wilson believes the stock market needs a new catalyst to resume its upward trajectory.

Wilson, the bank’s chief U.S. equity strategist, argues that investors betting on AI’s short-term potential may have jumped the gun. This trend is now visible in chip stocks, not just Nvidia’s recent fluctuations.

The Philadelphia Semiconductor Index has dropped 8.5% this month, indicating a broader cooling in the sector. Wilson notes that while AI’s transformative potential remains, its immediate market impact is waning.

Investors are now reducing their exposure to big tech stocks after heavily favoring them for much of the year. This shift comes as the Federal Reserve is expected to start cutting interest rates next week.

Wilson recommends defensive quality stocks in utilities, consumer staples, and healthcare as the chip manufacturer fervor temporarily subsides.

In addition, he suggests investors may seek refuge in these sectors until the next significant market development.

Market Update

U.S. stocks fell Tuesday morning after a key inflation measure rose more than expected in August. The core consumer price index increased 0.3% from July and 3.2% year-over-year.

Wilson warns that an aggressive 50 basis point rate cut at the upcoming Fed meeting could significantly reduce the chances of a soft landing. Most traders now expect a more modest quarter-point cut.

The strategist sees the Fed’s stance on quantitative tightening as the biggest uncertainty in next week’s policy meeting. Any surprise moves to provide liquidity could boost stocks.

Wilson accurately predicted a market pullback in early July due to Fed policy uncertainty, corporate earnings, and U.S. elections. The S&P 500 subsequently fell 8.5% from its peak to its August low.

Looking ahead to the elections, Wilson believes that in a soft landing scenario, former President Trump’s growth policies could benefit stocks.

However, these policies could harm bonds. This perspective adds another layer of complexity to the evolving market landscape.