Morgan Stanley Advises Shift To Defensive Stocks As AI Rally Loses Steam Following Drop In Nvidia And Others: 'We Got Overcooked On The Whole AI Theme'

Morgan Stanley is advising investors to pivot towards defensive stocks as the AI market loses momentum. This recommendation comes after a noticeable decline in semiconductor shares.

What Happened: On Tuesday, Mike Wilson, Morgan Stanley’s chief U.S. equity strategist, told Bloomberg Surveillance that the excitement around AI investments has diminished.

He noted that the semiconductor sector, including major players like Nvidia Corp. NVDA, has seen significant drops in stock prices.

“A lot of those stocks have really come off. And that makes sense to me. We just got overcooked on the whole AI theme,” said Wilson.

Wilson highlighted that semiconductor shares have fallen nearly 7% since Nvidia’s recent earnings report, with Nvidia itself experiencing a roughly 13% decline. He emphasized that this downturn doesn’t spell doom for the industry but indicates a longer-term benefit and return.

With the AI rally fading, Wilson suggests that investors should focus on “quality defensive stocks” in sectors such as utilities, staples, and healthcare. He believes these areas are well-positioned to perform amid a slowing labor market.

“With that theme now gone, the market is looking for a new theme. On the growth side, there isn’t one, so what it does is it hunkers down into defensive, high-quality assets until we get the next thing. Whether that’s a bad outcome or a positive outcome, they’re going to hide out in these areas,” Wilson said.

Investors looking to explore the defense sector may want to consider checking out defense-focused ETFs like Invesco Aerospace & Defense ETF PPA, First Trust Indxx Aerospace & Defense ETF MISL, SPDR S&P Kensho Future Security ETF FITE, iShares U.S. Aerospace & Defense ETF ITA, and SPDR S&P Aerospace & Defense ETF XAR.

Why It Matters: The shift in Morgan Stanley’s strategy comes amid broader market concerns. Last week, Tom Lee, co-founder and head of research at The Fundstrat, warned of a potential 7%-10% market pullback, citing historical trends that make September a challenging month for stocks.

Adding to the cautious sentiment, Bank of America advised investors to avoid increasing their exposure to the tech sector due to ongoing market volatility and election-related policy uncertainty. This aligns with Morgan Stanley’s recommendation to pivot towards more stable, defensive sectors.

Moreover, the Federal Reserve’s recent actions add another layer of complexity. On Wednesday, economists suggested that the Fed has the green light to cut rates, given the inflation rate fell to its lowest point since February 2021.

However, JPMorgan cautioned that these cuts might not significantly boost stock markets, as they are likely to be reactive to slowing economic growth.

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