Morgan Stanley Sends AI Trade Warning: Stop Buying

The market closed with mixed action on Friday. While Dell Technologies (DELL) delivered a strong report and gave the AI trade additional fuel, breadth was poor, with small caps lagging and only about 43% of stocks in positive territory. The Magnificent Seven (MAGS) was red, while the Invesco QQQ Trust (QQQ) managed a 0.5% gain. The Dow Jones Industrial Average (DIA) led the major indices with strength in IBM (IBM) and Salesforce (CRM). Dell surged nearly 30% and created sympathy moves in the tech sector.

There remain pockets of strong speculative momentum, but there is growing concern that things have gone too far, too fast.

Two Warnings from Wall Street

Morgan Stanley’s Daniel Skelly, head of market research and strategy at Morgan Stanley Wealth Management, warned the AI trade could cool in a setup “similar to the mid-1990s” and suggested pivoting from “buy” to “hold” on the AI infrastructure names. His specific concern was concentration. He wrote that the market’s concentration in semiconductors, IT hardware and power, the frontline beneficiaries of AI spending, has been extreme. The extent of the recent rally means it may now be better to hold the positions than to add to them.

His underlying assumption is that the history of tech suggests AI will be less compute and energy intensive a year from now, which implies less demand for some of the current market leaders. That is a longer-cycle call, not a near-term trade, but I expect to see more of these institutional calls questioning the trade that has been carrying the indices.

Bank of America was also bearish but came at it with arguments about technical conditions. Their strategists wrote that risk-reward is deteriorating and multiple indicators favor a more defensive stance. The base case is to maintain trend-following long positions through June and then prepare for a summer correction.

They specifically pointed to weakening market breadth and diverging momentum signals as the warning. They noted that fewer stocks are participating in the advance even as the headline indices continue climbing. Their window for elevated correction risk runs from June through September, with a fourth-quarter rebound expected, consistent with the second-year-of-the-presidential-cycle pattern. Their longer-term target stays at 8,000 on the S&P, matching Goldman Sachs, so the call is for a summer pullback inside an ongoing bull market rather than a major top.

The two warnings are based on different arguments but they reinforce each other. Skelly is questioning the concentration. BofA is questioning the breadth. Both are saying the next leg higher will be harder.

Catalysts Are Lining Up

These warnings align with the dangers I have been writing about which include a sell-the-news reaction to an Iran deal, the mega-IPO from SpaceX, and continued inflationary pressures. The retail sector is also a concern, especially after Costco Wholesale (COST) took a 4% hit following its earnings report. Walmart (WMT) is signaling similar margin pressure on consumer-facing names.

The Iran situation continues to drag out and is becoming downright annoying as the deal-or-no-deal dialogue has been repeated a dozen times. The market barely reacted to the latest round of back-and-forth, though oil prices remained soft. My concern is that when the resolution comes, it will be greeted with a sell-the-news reaction.

Speculation Is Still Where the Action Is

The best thing about this market recently has been the pockets of aggressive trading in individual stocks. Traditional Wall Street sees this kind of speculative action as a negative that is indicative of a market top, but it offers some good trading opportunities even if it is late in the cycle. The drone names, the AI energy suppliers, the quantum computing group, the smaller biotechs with their own catalysts, the space stocks riding the SpaceX excitement, and now Dell and the AI infrastructure sympathy are all delivering moves that reward selectivity and active stock picking.

Strategy

I am concerned about how the catalysts are lining up for some sort of corrective action, but I am going to keep on trading strong individual stocks as long as the price action cooperates. I am expecting that the month of June will see some substantial swings, with the Skelly call on concentration, the BofA window of June-through-September correction risk, the looming Iran resolution, the SpaceX IPO sometime in June or July, and the ongoing inflation pressure all converging into the same window.

I will maintain my reactive approach with high cash levels. Position sizing stays tight and stops stay disciplined. The opportunities are still there in the individual names, and I will keep working those, but the broader picture is signaling that the easy gains may be behind us and the harder gains will go to traders who stay nimble.

Have a great weekend. I’ll see you on Monday.