AI Deflation and the Great Sector Rotation: What Traders Should Watch Now
Investors await Trump at Davos, but the market remains resilient beneath the chaos. Here's where my game plan is focused.
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Stocks are finding tentative support on Wednesday morning after a chaotic market session on Tuesday. It was the deepest corrective action for the Magnificent Seven group of stocks since October, but there were no signs of broad panic or a rush for the exits.
The selloff was triggered by a combination of extended technical conditions, a surge in Japan's 40-year bond yield to a record high, threats of new tariffs by President Trump, and concerns about a battle over control of Greenland.
Small-Caps Take the Lead
The most interesting aspect of the action is that it accelerated recent rotational action. The Mag 7 were the losers while the Russell 2000 outperformed the S&P 500 for the thirteenth straight session.
Investors are now awaiting a special address by President Trump at the World Economic Forum in Davos, Switzerland on Wednesday morning. Trump will focus on policy success in his first year in office but is likely to delve into areas of concern such as Greenland and tariffs.
The Trump Market Effect
The president's pattern has been to be conciliatory after taking a provocative, extreme position, which probably prevented an even worse session on Tuesday. Trump is always sensitive to market reactions and is likely to calm tensions as he moves forward.
It is important to understand that the news flow itself does not necessarily drive market action. Instead, market conditions determine the impact of news. We are in the midst of fourth-quarter earnings season and at start of a new year with growing corrective action in big-cap technology. The AI bubble is not popping, but it is deflating, and that is triggering rotation into other areas of the market.
Earnings Expectations and Potential Surprises
Earnings reports will be very important in sending a message about the health of AI and related capital spending. A big selloff like the one we are seeing now has lowered expectations, so the potential for a positive response to "OK" reports and guidance is more likely. This is not a situation where there is a high risk of a "sell the news" response.
Netflix (NFLX) is the first big technology name to report. It disappointed and is down about 6% early on Wednesday. It will be instructive to see if there is bottom fishing interest.
Netflix stock has been in a nasty downtrend since topping in July, suffering a 40% decline from its highs, and is very deep into a bear market. This goes to show how far a technology darling can fall once it loses its luster.
Strategy: Small-Caps and Selective Big Tech
My game plan continues to be a focus on small-cap stock picking. That is where the strength is and this pullback is creating some interesting entry points.
I am also going to look at some of the Mag 7 names as possible trades heading into their earnings reports. Amazon (AMZN) and Google (GOOGL) look the most interesting to me.
At the time of publication, Rev Shark was long AMZN and GOOGL.
