The Fractured Momentum: AI Stock Earnings Underperformance and Its Impact on Investment Strategies

The AI stock market in 2025 has become a case study in the fragility of momentum investing. While the sector was once hailed as a guaranteed driver of growth, recent earnings underperformance has exposed deep structural vulnerabilities. Companies like BigBear.ai (BBAI) and C3.ai (AI) have exemplified the sector’s turbulence, with the latter dropping 32% after a dismal Q1 earnings report and the former declining 21% post-Q2 results due to revenue shortfalls and operational challenges [3][2]. These declines are not isolated incidents but symptoms of a broader shift in investor sentiment and market dynamics.

Momentum strategies, which rely on sustained price trends to identify “winning” stocks, have struggled to adapt to the AI sector’s volatility. The sector’s rapid leadership changes—defensive sectors like FMCG and pharma leading early in the year, followed by cyclicals like banks and capital goods—have created a “stop-start” environment rife with false signals [1]. For instance, the emergence of cost-competitive AI models like DeepSeek in early 2025 triggered a correction in high-beta AI stocks, eroding the confidence of momentum investors who had previously flocked to the sector [3]. This volatility is compounded by macroeconomic noise, including geopolitical tensions and regulatory uncertainties, which obscure fundamental signals [4].

Academic research underscores the challenges. A 2025 study found that AI-driven funds outperform in downtrend markets by mitigating downside risk but underperform during bull markets due to overly conservative positioning [4]. Conversely, human-managed funds excel in capturing momentum during recovery phases, suggesting a complementary role for AI in investment strategies. However, the current environment—marked by crowded momentum trades in AI-linked equities—has heightened the risk of sharp corrections. JPMorgan warns that speculative positions in high-beta AI stocks have reached historically high levels of crowding, making the sector vulnerable to sudden reversals [3].

The underperformance of AI stocks also highlights the limitations of momentum strategies during regime shifts. Historical data on the Nifty 200 Momentum 30 Index reveals that momentum strategies often experience prolonged drawdowns before recovering, with the 2024–2025 drawdown of -31.79% remaining unrecovered as of August 2025 [1]. This pattern suggests that while momentum investing retains a long-term edge, it requires patience and diversification to weather periods of underperformance.

For investors, the lesson is clear: the AI sector’s earnings underperformance and volatility demand a nuanced approach. Relying solely on momentum strategies risks overexposure to high-beta assets during market corrections. Instead, blending momentum with value and quality factors—while incorporating AI-driven tools to manage downside risk—may offer a more resilient framework. As the sector navigates its identity crisis, the ability to adapt to shifting regimes will separate the durable winners from the casualties.

**Source:[1] Momentum Strategies Are Underperforming in 2025 [https://www.wrightresearch.in/blog/momentum-strategies-underperforming-2025-data-insights/][2] BigBear.ai Stock Down 21% Since Q2 Earnings [https://finance.yahoo.com/news/bigbear-ai-stock-down-21-144600919.html][3] C3.ai Stock Sells Off After Dismal Preliminary Results [https://www.schaeffersresearch.com/content/news/2025/08/11/c3ai-stock-sells-off-after-dismal-prelminary-results][4] Comparative analysis of AI-driven versus human-managed funds [https://fbj.springeropen.com/articles/10.1186/s43093-025-00540-8]