AI confidence loss could amplify market declines, BofA says

A handful of AI-related stocks have captured the bulk of recent gains, potentially hiding broader market fragility beneath an index-level calm. If sentiment towards AI sours, headline benchmarks could be more exposed than they appear. According to BofA, earnings reports, capital expenditure updates, and indications of reduced spending in AI sectors could become key movers for US equities, outweighing the impact of yield changes – at least until yields rise further. Observers might track the divergence between AI leaders and the rest of the market, especially small caps, to assess the extent of the so-called 'AI put'. This analysis reflects one team's interpretation, not a consensus, and relies on investor psychology, which can turn quickly.

This latest development does not alter the outlook:

• Fed's Kashkari sees inflation still too high, pencils in one more hike this year

The bank contends that AI excitement is now playing the role previously held by the 'Fed put' in cushioning markets. Therefore, a shake in that conviction, rather than rising yields, is the key threat to watch. Information via Dow Jones / Market Watch.

The following points summarise the report:

• BofA strategists highlight that the primary risk to US equities is eroding faith in AI, dubbed the 'AI put', not higher bond yields.
• They argue that FOMO around AI is fueling aggressive buying on dips and diverting attention from macroeconomic hazards.
• They draw a parallel to the 'Fed put', with AI fervor providing a buffer as the Fed resumes rate hikes.
• The 20 best-performing members of the S&P 500 have accumulated approximately $1.7 trillion in market value from August 31, whereas the remaining 480 have lost roughly $1.9 trillion.
• Small and midcap stocks, along with financials and utilities, have faced pressure as yields climbed to multi-decade peaks.
• BofA suggests that higher Treasury yields will eventually hurt equities, but likely at a level higher than most anticipate.

According to BofA Global Research, the greatest threat to US stocks is not climbing bond yields but a potential erosion of investor trust in AI, which they term the 'AI put'. The team stated in a report that AI-related FOMO is capturing investor focus and prompting strong buying on declines, making it difficult for macro risks to gain attention.

The phrase 'AI put' is derived from the 'Fed put', the long-held market expectation that central banks intervene when asset prices fall. BofA posits that, with the Fed starting a new cycle of rate increases, AI optimism is fulfilling a comparable supportive function for equities. The bull market will turn four years old in October, and the strategists view its survival as largely dependent on sustained AI enthusiasm.

Recent market developments align with this analysis. As bond yields rose to multi-decade highs, the rally, which had been widespread, became highly concentrated. Small- and mid-cap stocks, more interest-rate sensitive, declined, and so did financials and utilities. The Dow Jones Industrial Average, with less AI exposure than the S&P 500 or Nasdaq, also lagged. AI stock gains obscured a lot of this weakness. According to market data, the top 20 S&P 500 stocks, predominantly tech and industrial companies, have added roughly $1.7 trillion in market value since August 31, while the other 480 have shed about $1.9 trillion. The S&P 500 was on track for a roughly flat September.

The strategists highlighted a major distinction from the original concept. The Fed put relies on a single institution's decisions, while the AI put rests on the confidence of millions of investors, far harder to measure. A crucial issue is the source of returns on the massive AI investments. Goldman Sachs and other analysts estimate that over $1 trillion has been poured into data center construction since late 2022. One economist remarked that technology analysts foresee cash flows skyrocketing by 2028, but analysts covering industries that would use AI services are much more cautious, indicating a disconnect across sector forecasts.

BofA conceded that a threshold exists where rising Treasury yields would begin to pressure equities, but added that level is likely above typical investor expectations. If AI confidence wavers, the report cautioned, it could converge with an unclear macro environment and amplify losses throughout markets.