Tech stocks pull back, while other markets continue to rise: a market rotation signal emerges.

Tech Stocks Correct, Rest of Market Continues to Rise: Signals of Rotation Emerge

Over the past decade, a core concern has lingered over the bull market in U.S. stocks: What would happen if tech stocks, which carry a massive weight in the S&P 500, suffered a sharp decline? This week, investors witnessed that scenario firsthand, but the outcome was surprisingly calm—tech stocks did take a heavy hit, yet the rest of the market continued to move steadily forward, even hitting new highs.

This phenomenon suggests a profound asset rotation is underway, with institutional investors reassessing the long-term valuations of AI themes and rotating capital toward sectors with stronger value support.

Market Background

The current macroeconomic environment shows the following characteristics:

• Interest rate environment: The Fed maintains rates at a high of 5.25%-5.50%, with market expectations for rate cuts this year being repeatedly adjusted; the 10-year Treasury yield fluctuates in the 4.2%-4.5% range.
• Inflation stickiness: Core PCE remains above 3%, services inflation is stubborn, and the trend of goods disinflation is slowing.
• Economic growth: GDP growth has moderately declined to around 2%, but the job market remains tight, and consumer spending is resilient.
• Liquidity: The Fed continues its balance sheet reduction, but overnight reverse repo balances are declining; bank reserves are ample, and market liquidity has not tightened sharply.
• Policy environment: Policy uncertainty rises in an election year, with tariff and industrial policy risks affecting confidence in some industries.

In this context, the high valuations of growth stocks are more sensitive to rate changes, while value and cyclical stocks benefit from expectations of a soft landing.

Current Capital Flows

According to Barron's, funds are exiting traditional AI hot stocks from two directions:

• From AI chips to software: The iShares Expanded Tech-Software Sector ETF (IGM) outperforms the VanEck Semiconductor ETF (SMH), with software stocks like ServiceNow, Workday, and AppLovin leading gains, while chip stocks like Nvidia decline.
• From tech giants to other sectors: Although the S&P 500 fell overall, the equal-weight index and the Dow Jones Industrial Average remained strong, with sectors like industrials, financials, and energy attracting capital.

This rotation suggests that institutional investors are not broadly bearish on tech, but rather correcting the extreme valuation divergence.

Investment Logic Analysis

Why are capital flows changing? The driving factors include:1. Valuation Pressure: After a year and a half of gains, AI bellwether stocks generally have P/E ratios exceeding 30x, with some above 50x, while other sectors are more reasonably valued. In a high-interest-rate environment, investors are beginning to demand higher risk premiums. 2. Narrowing Earnings Growth Expectations: Market expectations for AI earnings have shifted from "explosive growth" to "steady-state growth." The semiconductor cycle is entering a mature phase, while software companies, benefiting from AI application deployment, have higher earnings certainty. 3. The "Bad News Is Good News" Game: Weaker economic data may accelerate interest rate cuts, benefiting rate-sensitive assets, and funds are rotating from defensive tech stocks to a broader range of cyclical stocks. 4. Long-Term Trend Shifts: Themes such as the energy transition, military modernization, and digital economy infrastructure are attracting long-term capital. Institutional investors are beginning to balance their AI exposure within portfolios.

Risk Factors

Although the market rotation appears healthy, the following risks need attention:

• Macro Risk: If the economy experiences a hard landing, the rotation could evolve into a broad decline, putting pressure on all sectors.
• Policy Risk: Fiscal policy changes after the election may affect specific industries, such as tech regulation or adjustments to energy subsidies.
• Geopolitical Risk: US-China tech competition, the situation in the Middle East, the Russia-Ukraine conflict, etc., could impact supply chains and market sentiment.
• Market Valuation Risk: Even after the tech stock pullback, the S&P 500's overall P/E ratio remains above 20x. If earnings disappoint, further adjustments could be triggered.

Long-Term Outlook (3-10 Years)

From a structural trend perspective, the AI investment theme has not disappeared but has entered a second phase: shifting from hardware investment to application deployment. Institutional investors will continue to allocate to AI but will focus more on earnings visibility. Meanwhile, the following long-term trends will affect asset allocation:

• Interest Rate Cycle: Over the next three years, global interest rates may gradually decline from highs, benefiting bonds and dividend-yielding assets.
• Demographic Structure: Aging populations in developed economies drive investment demand in healthcare and automation.
• Energy Transition: Capital expenditure in clean energy is expected to grow at a compound annual rate of over 10%, offering broad infrastructure investment opportunities.
• Emerging Markets: Capital inflows to regions like India and Southeast Asia are accelerating, becoming an important direction for diversified allocation.

For institutional investors, the current market rotation provides an opportunity to rebalance portfolios: reduce holdings in overvalued tech stocks, increase positions in sectors that benefit from economic resilience and are reasonably valued, and seek cost-effective opportunities within long-term growth themes.