AI sell-off: healthy market rotation or warning sign?

How was October for you? Well, that would depend on what your investment portfolio looked like at the start of the month.

For anyone still drinking the AI Kool Aid, it was a shocker. It was the worst month for the Nasdaq Composite index since March 2025. The index fell 5.3%. The fall last Friday alone was 2.9%. The tech-heavy index was almost 8% below its high point early in the month.

At the individual stock level, things were even worse. It was the worst month ever for Google-owner Alphabet. Its shares fell 12% in one day and 19% for the month as a whole. Intel had its worst day since 1974, falling 29% on the last trading day of the month. The Korean market, dominated by chip makers SK Hynix and Samsung, closed the month 16% down. Meta lost 15%.

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But other investors might be wondering what all the fuss is about. If your exposure to the stock market is, like many people’s, via a US stock market tracker, your portfolio will have ended the month less than 1% lower than it started.

If you had paid attention to the many market watchers warning about the S&P 500’s excessive concentration in technology stocks and opted instead for a fund tracking the equal-weighted version of the US benchmark, you would be 5% up. The broad-based Dow Jones Industrials index never fell into negative territory.

The Russell 2000 smaller companies index ended the month above water. As did the more defensive UK and European stock markets. If you’d really taken risk off the table, you could have made 10% by focusing on utilities or consumer staples. Correction, what correction?

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Not only has a handful of giant US companies come to dominate the most widely watched indices, it has also come to dominate investors’ perceptions about how the market is doing. October was far less scary than a month of investment doom scrolling might have led you to believe. At the end of September just one in five companies were trading above their 50-day moving average. By the end of October, it was 61%.

Far from a market-wide correction, October looked a lot more like a healthy rotation. The optimistic view of the move out of tech and into a wide range of other sectors, geographies and themes is that the bull market is broadening rather than rolling over. Last week, nine of the eleven sectors in the S&P 500 rose despite the tech sell-off. This feels like a change of leadership rather than a retreat from risk.

If you were feeling provocative, you might even make a case for an AI correction being good for the broader economy. In recent years, spending on AI infrastructure has boosted economic activity, but it has also absorbed huge amounts of capital, labour, energy and computing capacity. That has caused bottlenecks and contributed to inflation. A moderation in the AI boom might reduce some of the pressure.

The sweet spot for the broader economy might be the moment when the AI pioneers are no longer enjoying scarcity-pricing, and companies and households more generally are starting to enjoy a cheaper and more widely available technology.

If computing capacity becomes abundant and AI services cheaper, businesses throughout the economy could benefit without having to spend heavily on developing the technology themselves. The AI revolution could be successful, even if many of today’s AI investments turn out to be disappointing.

That said, there is certainly a risk that a rotation out of tech could morph into a more serious market correction. This could happen in a handful of ways.

AI spending has been a powerful driver of economic growth for chip makers, cloud providers, construction companies and utilities. A slowdown in capex could ripple out through these companies’ supply chains. What started as a valuation correction could become an earnings recession.

With the Magnificent Seven representing such a large part of the value of the US stock market, continuing declines could hit household wealth, confidence and consumer spending. Investors losing money in tech stocks could be forced into indiscriminate selling of other apparently unaffected investments.

So, how might we tell if the rotation is benign or something more serious? There are a few indicators I’ll be keeping an eye on for the rest of the year. First, market breadth - are more stocks advancing than declining? Is the equal-weight index outperforming the headline index, and in positive territory? Are earnings revisions positive in non-tech sectors? Are credit spreads contained or widening? Are bond yields stable or easing in an orderly way?

And while I’m studying the tea leaves, what will I do with my investments? The first thing I’ll inspect is the underlying exposures in my portfolio. How much hidden tech exposure do I have in tracker funds, for example? I’ll also ensure that I remain diversified by sector, geography and investment style. This is not a moment for big bets.

What I will not do is assume that history will repeat itself. There have been good examples in the recent past of a sell-off in one sector being shrugged off in a healthy way that rewarded staying the course, and in others when it was the prelude to a painful wider correction.

The bursting of the technology bubble in 2000 initially saw value and defensive shares outperform, but the wider market was soon infected by falling earnings and worsening sentiment. Likewise, four years ago, rising bond yields initially targeted growth shares but weakness soon spread out across other sectors too. Ten years ago, by contrast, leadership broadened out nicely towards financials, industrials and cyclical companies as global growth improved after the financial and sovereign debt crises.

It is tempting to conclude that a technology correction could be just what the stock market needs. But in investment, as elsewhere, we should be careful what we wish for.

This article was originally published in The Telegraph.

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