BofA Securities says the recent decline in Japan's AI-focused shares is best viewed as a healthy rotation in equity markets rather than the beginning of a broad-based slump. The brokerage cautions investors to diversify holdings as macroeconomic risks increase and valuations remain elevated.
Drivers of the pullback
According to the bank, sentiment toward AI names has been weighed down by a number of industry-specific and market factors. These include doubts about whether AI-driven data center spending can be sustained at its prior pace, rising costs for memory components and AI compute tokens, and a rotation of attention toward lower-cost Chinese open-source AI models. At the same time, a drop in crude oil prices and higher U.S. real interest rates have prompted investors to redeploy capital away from AI and into other areas, even as headline benchmark indexes obscure the magnitude of these underlying shifts.
Principal market risk highlighted
BofA identifies the most significant market risk as a sustained spike in oil prices that would force the Federal Reserve to hold a tighter policy stance. In that scenario, real interest rates could move higher and produce a steeper selloff in richly valued AI stocks. The bank regards that scenario as unlikely in the near term, noting that rising gasoline prices would present political complications for U.S. President Donald Trump ahead of the midterm elections.
Positioning and investor behavior
The brokerage also points to crowded positioning as a contributor to the weakness in AI shares. High-beta, high-valuation names have reversed after an extended rally, according to BofA. The firm advises investors to keep AI-related holdings but to broaden exposure elsewhere, arguing that only an extreme and sustained rise in market concentration on the order of the dot-com boom or the 2008 financial crisis would indicate a far more serious market breakdown.
Seasonality and expected recovery path
Seasonal patterns have further supported the rotation, BofA says, noting that momentum stocks commonly weaken between late June and early August as earnings revision momentum fades. While the bank acknowledges that AI-linked equities could recover after first-quarter earnings announcements, it expects any rebound to be gradual rather than immediate.
Portfolio guidance
On positioning, BofA recommends retaining exposure to AI-related names but avoiding companies with excessively stretched price-to-earnings multiples. The firm suggests increasing allocations to stable-growth companies and to selected non-AI sectors that may benefit from broader market participation and lower oil prices. Those recommended areas include banks, defense, construction, real estate, retail and food.
Note: This analysis reflects the views reported by BofA Securities and summarizes the drivers, risks and recommended positioning the brokerage has identified in relation to recent moves in AI-related stocks.