Stock Markets Under Fire: Is the AI Boom Rally Overheating?

Stocks fell, the dollar surged, and bonds crept higher — the classic fingerprints of a growth scare. Is this selloff an unwind of AI hype or something worse?

• Technology led stock market losses while defensive sectors gained, a rotation that points beyond mere profit-taking on the “AI boom” trade
• Treasury yields ticked lower and the dollar jumped — that looks like capital fleeing into cash and safety, not just worrying about inflation
• June PMI data shows booming manufacturing and a stalled service sector across major economies. In Europe and Australia, that growth mix is already failing

Has sentiment finally broken? Stock markets swooned in Wall Street trade. The bellwether S&P 500 took out near-term support just under 7500 and could be carving out a major top, having lost steam on a climb from 7200 toward 7600 amid fading volume and waning momentum studies yet again.

This looks like a growth scare, not just an AI unwind

The selling was led by the technology names, down nearly 4%, with cycle-sensitive sectors like basic materials and industrials close behind. Meanwhile, defensive sectors rose — consumer staples added almost 2%, while healthcare and real estate rose nearly 1.5%.

This ominous mix seems to point to something more than just investors trimming exposure to frothy trades tied to the artificial intelligence (AI) boom. It may point capital repositioning for trouble in the economy itself.

The cross-asset picture sharpens the point. Gold fell and the US dollar surged, punching further past the range top that had contained it for nearly a year. Crucially, Treasury bonds did not keep sinking as they have when traders’ fears hinged on the US-Iran war and its inflation implications; instead, yields ticked slightly lower on the day.

A simultaneous decline in stocks and most commodities, paired with firmer bonds and a soaring dollar, is “risk-off” price action in its classic form — capital fleeing less liquid, riskier assets and rushing into cash and the deepest pool of safety, US Treasuries. This flight to liquidity hints that the wartime “inflation trade” is evolving into something much more sinister.

Notably, this is happening as oil keeps falling

All of this unfolded while the supposed source of the malaise was easing: crude oil broke below its wartime range and is approaching pre-war levels, its uptrend abandoned, as Washington and Tehran commit to a 60-day peacemaking window and geopolitical risk premium drains out of prices. 

If the war were still the chief worry, sentiment should be improving. It is deteriorating instead, confirming what the rates trade has signaled for weeks. For markets, the conflict was always primarily an inflation story: from an energy shock to the resulting upward squeeze on rates, and the fragile growth underneath. Traders now seem to be eyeing the next chapter: not the inflation, but the downturn that it threatens to cause.

The PMIs reveal a dangerous imbalance

June’s US purchasing managers index (PMI) data looked strong on its face, pointing to the fastest economic activity growth since January. Under the surface, however, that progress has come thanks to a booming manufacturing sector, while services are managing little better than standstill. This looks like the same lopsided mix that defined first-quarter Gross Domestic Product (GDP) data: growth is powered by overclocking the smaller of the economy’s output engines. Not surprisingly, that is stoking inflation.

Economies outside the US show where this can lead. Analog PMI data showed that across Australia, the Eurozone, and the UK, manufacturing is booming yet the economies are contracting, because a shrinking service sector is far larger and drags the whole down. The US and Japan are still growing thanks to their deeper ties to the AI buildout, making the boost from manufacturing more potent, but the baseline imbalance remains. Growth is yet to falter under the weight of a sluggish service sector, but the direction of travel seems to be unmistakable.

Why the imbalance was never sustainable

The math has always been precarious. GDP grew just 1.6% in the first quarter — less than half the roughly 4% pace of last year’s middle quarters — and it managed that only because business investment, about 14% of the economy, expanded at a scorching 10.4% annualized clip and out-contributed consumption, which is 68% of output and has retrenched for two straight quarters. 

That such an arrangement can be sustained for any significant period of time has always appeared suspect. The idea that investment could spin fast enough to carry growth over a longer term even as the inflation it threw off bore down on the five-times-larger consumer sector was never plausible for long. Sooner or later the gravitational pull of retrenching consumers proves too strong to resist and growth slips, as the PMI numbers from Europe and Australia readily attest.

The latest defensive stock market rotation, firmer bonds, and surging dollar suggest that traders are beginning to suspect that a turn of some sort is near. The Federal Reserve, having shifted decisively hawkish and now priced to hike interest rates as soon as September, is in no position to cushion the blow. The relief that carried stocks back toward their highs this month may be running out of road.

Ilya Spivak, tastylive Head of Global Macro, has over 15 years of experience in trading strategy. He specializes in identifying thematic moves in currencies, commodities, interest rates and equities. He hosts Macro Money and co-hosts Overtime, Monday-Thursday. @Ilyaspivak

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