AI Selloff: A Product of Deleveraging
Thursday, investors finally got an answer as to why there was a cascade of selling in AI-related stocks. First, AI-related stocks became extremely overextended as ‘irrational exuberance’ took hold on Wall Street. However, as I wrote in my early June commentary “Priced to Perfection? Select AI Stocks Set Up Climax Tops”, too much of a good thing can become a bad thing. Here is a quote from that article:
“When a child gets given a giant bowl of ice cream after a full day of activity, its hard for them to imagine anything better. However, while the first few bites are almost always filled with pure joy, eating too fast or too much can trigger a brain freeze, sugar crash or stomach ache.”
That’s exactly what began to appear in the technical patterns of leading AI stocks like Micron (MU) and SanDisk (SNDK). Both of these stocks began an accelerated trend, printed multiple exhaustion gaps, and became hyper-extended relative to their 200-day moving averages – classic signs of a climax top.
Leverage Intensified the Selling in AI Stocks
As summer approached, AI stocks were riding high as retail investors piled in. However, on July 16th, China-based Moonshot AI released its groundbreaking AI model dubbed ‘Kimi K3.’ Kimi K3, an open-source AI model, threatened US-based AI leaders because of its extreme efficiency and robust performance metrics. Following the release, investors punished AI infrastructure stocks, fearing that increased efficiency would lead to lower demand for AI infrastructure.
The news triggered selling that would equate to the worst destruction in momentum stocks since the COVID-19 market crash. However, the selling was intensified by hyper-leverage. For instance, South Korean regulators approved 2x-levered ETFs on its top tech stocks. Meanwhile, Situational Awareness, one of the most widely followed AI-focused hedge funds, suffered a 90% drawdown in July. The result? Over 1 million South Korean retail accounts suffered a margin call, and Situational Awareness was forced to liquidate its publicly traded positions.
Why AI Infrastructure Stocks are a Buy
The carnage in AI infrastructure stocks is breathtaking, with many down more than 50% in the past few months. However, often on Wall Street, crisis equates to opportunity. Below are four reasons to buy AI infrastructure stocks here:
1. Kimi K3 Fears are Overblown: The improved efficiency in AI models is not a death sentence.A concept called ‘Jevon’s Paradox’ suggests that when a tool or machine makes using a resource more efficient, the total amount of that resource goes up, not down.
2. CAPEX Spending Isn’t Slowing: Big tech spending on AI infrastructure is not slowing any time soon. For instance, Meta Platforms (META) and Alphabet (GOOGL) each raised their CAPEX spending expectations for 2026.
3. Shorts are Caught Offside: The latest data shows that short sellers have piled into AI infrastructure stocks such as Cipher Digital (CIFR) and Nebius Group (NBIS). After Thursday’s market gains, these short sellers will be forced to unwind their positions over the coming weeks.
4. Forced Selling Reset: The forced selling by overleveraged investors likely caused an overshoot to the downside.
The recent violent selloff in AI infrastructure stocks was painful but necessary. With the core fundamentals intact and leveraged players out of the way, the stage is set for a violent rebound in AI infrastructure stocks.
Beyond Nvidia: AI's Second Wave Is Here
The AI revolution has already minted millionaires. But the stocks everyone knows about aren't likely to keep delivering the biggest profits. AI’s second wave is moving from infrastructure to implementation and these companies are at the forefront of this transition, positioned to become what Amazon and Google were to the internet era.
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Micron Technology, Inc. (MU): Free Stock Analysis Report
Sandisk Corporation (SNDK): Free Stock Analysis Report
Alphabet Inc. (GOOGL): Free Stock Analysis Report
Meta Platforms, Inc. (META): Free Stock Analysis Report
Cipher Digital Inc. (CIFR): Free Stock Analysis Report
Nebius Group N.V. (NBIS): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).