AI Enthusiasm Cools as Tech Stocks Tumble: Nasdaq's Sharpest Drop in Months Spurs Market Rotation

On August 19, U.S. tech stocks experienced a significant downturn, marking the most severe sell-off in several months. The sell-off, led by high-profile artificial intelligence stocks, brought an end to the impressive rally driven by AI enthusiasm. Skepticism regarding the commercial viability of AI, combined with warnings of a potential bubble from industry leaders, prompted investors to exit high-momentum tech stocks.

The tech-heavy Nasdaq Composite Index closed down by 1.4%, its largest single-day drop since August 1, with chip giant NVIDIA falling 3.5%. Other notable declines included a 9.4% drop for Palantir and a 5% dip for Arm. The S&P 500 Index also closed lower, down 0.7%.

This retreat aligns with growing concerns about high valuations in tech stocks. The catalyst for market tension was a report from a Massachusetts Institute of Technology (MIT) research branch, which revealed that 95% of organizations saw zero returns from generative AI investments. This, coupled with OpenAI CEO Sam Altman's comments on overexcitement around AI, aroused fears of a bubble.

Immediate negative reactions ensued, with a trader from a billion-dollar U.S. tech fund admitting the MIT report "scared people." The sell-off extended to other risk assets, with Bitcoin falling 2.7%, impacting related crypto stocks. Investors shifted capital from tech into defensive sectors, with the Dow outperforming tech stocks four times in the past five trading days.

The sell-off focused particularly on "high momentum" stocks that had been top performers earlier this year. The S&P 500 Information Technology sub-index, which rose 14% since mid-May, led the day's declines, as NVIDIA, Palantir, were among the worst hit. Comments from fund managers underscored the day's market adjustment as a rotation out of high-flying stocks rather than indiscriminate selling.

In contrast to tech's decline, defensive sectors like consumer staples, utilities, and real estate saw gains, with around 70% of S&P 500 constituents closing higher. This divergence highlights the structured nature of the tech slump. U.S. Treasury prices rose, driving yields down and reflecting increased risk aversion.

In parallel, other risk assets didn't escape unscathed. Bitcoin hit its lowest since early August, as did Ethereum. This pullback has prompted the market to closely monitor upcoming events such as the Jackson Hole Federal Reserve Conference and NVIDIA’s earnings report. These will be key in gauging whether confidence in AI's long-term value can be rekindled.