Technological innovations tend to be disruptive and dynamic. That's especially true with AI, which has the potential to disrupt itself, as evidenced by its ability to write software code, including AI code. So it can feed on itself, with the new code eating the old, making it obsolete very quickly. The pace of obsolescence seems to be moving at warp speed for both AI hardware and software, particularly the LLMs. That pace has recently spooked investors who've been selling the stocks of any company that might be negatively disrupted by AI.
The first casualty so far this year has been the software industry's stocks. The iShares Expanded Technology -Software (IGV) is down 24.6% ytd (chart). Last week, investors started to cherry-pick among some of the beaten-up stocks in search of the companies that might benefit from AI rather than be destroyed by it.
Investors also last week continued to pummel the S&P 500 sectors that might be adversely affected by AI and flock to those that seem most immune to disruptive AI (chart). So there has been a significant rotation in the stock market away from sectors representing less certain bets on the virtual world back to those representing the more predictable physical world, i.e., the S&P 500’s Energy, Materials, Consumer Staples, Industrials, Real Estate, and Health Care sectors.
Investors are rotating among sectors of the stock market rather than moving from stocks to cash. That's because the earnings outlook remains strong. Industry analysts have continued to raise their earnings-per-share estimates for 2027, which hit a record $363.27 last week (chart).
The bull market in the S&P 500 began to broaden during the second half of last year as industry analysts grew increasingly bullish on the earnings outlook for the S&P 500's Impressive-493 while maintaining their optimism about the Magnificent-7 (chart). The rotation from the former to the latter accelerated since late October 2025 as investors lost confidence in their own ability to call the winners and losers in the AI marathon.
The broadening of the bull market in stocks has been supported by increases in the percentages of S&P 500 companies with positive 12-month percent changes in forward revenues and forward earnings to 83.5% and 80.3%, respectively (chart).
The S&P 500's Magnificent-7 have continued to underperform the S&P 500's Impressive-493 since late October 2025, when investors became increasingly concerned that the former's AI arms race was forcing them to spend too much on AI infrastructure (chart).
In the past, the stock market often became increasingly concentrated in a few names during bull markets and less so following bear markets (chart). Will this time be different? We think so. The bull market should remain strong as it broadens.
Meanwhile, the US MSCI continues to underperform the All Country World ex-US MSCI (chart).
Japan's MSCI continues to outperform the US MSCI now that the new government has won a decisive majority in Parliament and is expected to proceed with a program of fiscal stimulus. Also outperforming the US is the Emerging Markets MSCI, which has been boosted by very strong forward earnings projections, especially for South Korea and Taiwan (chart). These two countries export the GPUs and memory chips ("picks and shovels") needed to expand AI capacity. Other emerging economies are benefiting from soaring commodity prices and expanding middle-class consumers.
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