If July 11 marks the bursting of the AI bubble in the US stock market, what will happen next?

On July 11th, the U.S. stock market experienced a dramatic volatility, with a historic "big reversal" between small-cap stocks and large-cap tech stocks.

In the S&P 500 Index, 396 stocks rose, but the overall index fell by 0.88%. At the same time, the S&P 500 equal-weighted index rose by 1.17%, the small-cap Russell 2000 Index rose by 3.57%, marking its best single-day performance since November last year. This also represents the largest performance gap between the overall S&P 500 Index and the S&P 500 equal-weighted index since November 2020.

Some media analysis suggests that the sharp decline of the seven giant stocks in the U.S. has triggered a market "big rotation." The seven giants experienced their largest drop since October 2022, falling by 4.26%. Over the past 5 days, the seven giants have suffered a historic defeat, with a market value evaporation of over $1 trillion.

In addition, the NASDAQ Index also recorded its largest single-day decline since 2022, while small-cap stocks surged in the opposite direction.

Looking back at history, during the bursting of the 2000 tech bubble, the market experienced similar fluctuations. Jim Reid of Deutsche Bank pointed out that at that time, tech stocks underwent a huge rotation, and the market's largest decline had not yet occurred.

Reid illustrated the scene before the bursting of the tech bubble in March 2000 through charts: defensive industries such as consumer staples, healthcare, and utilities plummeted, while tech stocks attracted a large amount of capital. When the bubble burst, funds quickly flowed back, resulting in defensive industry stock prices rising by 35-45% by the end of the year compared to when the bubble burst in March.

Although the S&P 500 Index fell by 10% in the three weeks after the bubble burst, by September, it had returned to near the peak of the tech bubble. It wasn't until 2001 and 2002 that the market experienced larger declines, coinciding with the eventual economic downturn and corporate fraud scandals (such as Enron and WorldCom) at the time, which were only possible in the frenzy of the first tech bubbleReid believes that this historical phenomenon may repeat itself.

"It makes people wonder, what kind of corporate fraud will emerge once the AI bubble bursts."

In the end, the market values of technology companies and telecommunications companies fell by about 85% and 75% respectively from their peak at the end of 2002. At this time, consumer staples were more than 25% higher than the tech peak in March 2000.

In fact, this time is different, the seven giants are largely "cash cows", generating hundreds of billions of dollars in cash each quarter, and more importantly, their revenue and profit growth rates are much faster than the other 497 stocks.

Reid believes that although the overall positioning of the S&P 500 index is very high, it is driven by the extreme positioning of mega-cap growth stocks and tech stocks. The positioning of most other industries is at or below average levels. This difference reflects the recent profit growth achieved, with the former achieving a year-on-year growth of 38% in the first quarter, while the latter (i.e., other industries) only achieved a year-on-year growth of 2.5%.

Analysts at Deutsche Bank predict:

This huge gap will narrow by the end of the year, with expected year-on-year growth of 30% and 7.5% in the second quarter... by the end of the year, both year-on-year growth rates will be around 10%, and the positioning should also be adjusted accordingly, which will have an impact on market rotation.

As Reid also pointed out, most US stocks are likely to rise by the end of the year, while the overall market may decline