Good morning investors,
Markets return from the Presidents' Day holiday to futures pointing lower. The technology led weakness continues a pattern that has now produced the Nasdaq's fifth consecutive losing week, its longest such streak since 2022. Yet beneath the surface carnage in mega cap tech, a different story is unfolding that validates the thesis I laid out coming into 2026.
The divergence is as clear as it is painful for bulls of the AI trade. Year to date, the S&P 493 is up 2.68% while the Magnificent Seven as a group are down 6.43%. The equal-weight S&P 500 tells a similar story, while the traditional market cap weighted index is flat, the equal-weight version is up more than 5%. Capital is not leaving the market. It is rotating from tech to other sectors. For the first time in years, gains are becoming less narrowly concentrated in a handful of trillion-dollar companies. Historically, that is a sign of improving market health, breadth, and participation.
Opening Bell
Futures reflect continued AI disruption anxiety spreading through multiple sectors, with the Nasdaq 100 ($QQQ ( ▲ 0.03% )) futures down 0.7%, S&P 500 ($SPY ( ▲ 0.16% )) futures off 0.3%, and Dow ($DIA ( ▲ 0.12% )) futures slipping 46 points. Meta and Nvidia are each down around 1% in premarket trading, with Palantir off 1.8%. Memory chip makers like Micron and Sandisk, which have been winners this year, are also lower. The iShares Software ETF ($IGV ( ▲ 0.19% )) is down 1% in premarket, set to extend its 21% loss for the year.
Today's economic calendar is quiet, with ADP weekly employment data the main release. Fed Governor Michael Barr speaks this afternoon on "Artificial Intelligence and the Labor Market," which could provide interesting perspective on how policymakers are thinking about AI's impact on employment. On the earnings front, Medtronic, Palo Alto Networks, and Constellation Energy report.
Warner Bros. Discovery announced it will reopen deal talks with Paramount Skydance under a 7-day waiver from Netflix, with Paramount reportedly offering $31 per share if discussions proceed. Both stocks are up roughly 3% in premarket on the news.
The AI Disruption Trade: Week in Review
Last week was brutal beneath the surface. Software, financial services, retail, and logistics all faced selling pressure as the AI fear trade migrated from sector to sector. A press release from a karaoke machine maker claiming its AI logistics platform could scale freight volumes 300-400% without additional headcount sent CH Robinson Worldwide and Universal Logistics down 12% and 10% respectively for the week.
AppLovin fell 18% after earnings disappointed. Pinterest dropped 21% after its results. Even Big Tech sold off, with Nvidia, Alphabet, and Amazon all slipping Friday despite spending projections from the largest companies continuing to boom.
The S&P 500 is roughly flat for the year, but this remains a bull market overall. The whole world is expecting a move to the downside next, and I would not disagree that risk exists, but the market has a funny way of making short-term speculators wrong. While I do expect some weakness this month, and a larger pull back at some point this year, group think is a major risk in the markets, and everyone that I read calling for 20%+ years again this year, is now leaning bearish. Funny how that works.
Sentiment: Extremely Bearish, Which Is Notable
The contrarian signals are flashing. Short interest in the technology sector ETF XLK has risen to 1.8%, the highest in at least six years. This percentage has doubled over the last few weeks. On Wednesday alone, investors shorted over 58 million Microsoft shares, representing roughly 0.8% of its free float, near the high end of its five year range. Salesforce has approximately 18 million shares sold short, or 1.9% of its free float, its 100th percentile over recent years. Short interest in the software ETF IGV spiked to roughly 19% last week, near the highest on record.
Periods where tech has been highly shorted like this in the past have caused squeeze moves. February month end is a historically weak for equity markets, and considerable focus is being placed on this, but any hint of a positive market move over a few days and we could see significant bounces in beaten down names.
The magnitude of the drawdowns in mega cap tech is striking: Microsoft is 27% off all-time highs, Amazon 23%, Meta 20%, Tesla 16%, Nvidia 14%, Google 12%, and Apple 11%. These are substantial pullbacks in the world's largest companies.
Opportunities in the Volatility
I believe there is significant long term opportunity emerging from this dislocation. Microsoft is approaching its 200-day moving average, with levels between $360-410 representing what I view as great long term value. The company's enterprise positioning, cloud infrastructure, and AI integration into productivity tools create durable competitive advantages that this sell off is not properly reflecting.
I continue to like cybersecurity at these levels. These names should not have been pulled down with software broadly, but their inclusion in IGV has hurt them in the indiscriminate selling. CrowdStrike and Palo Alto Networks at current prices look attractive given their best in class positioning in a space where demand remains structural. Salesforce, which I mentioned last week, still looks compelling at these levels despite the disruption concerns.
On the short side, I am watching Western Digital. It produced a very bearish candle in a failed move to break all time highs on Friday. Failed bullish moves like this can be bearish, and the stock has gone straight up. I think it could pull back to $220. I am watching for a push and fail to break $296 again or a move below $260 followed by a rejection at $260 for this trade. A stock like that would be super high risk given the incredible momentum, and there is no guarantee I am right. But when moves get overdone, reversion becomes more likely.
Macro Picture: Surprisingly Constructive
Last week's data was better than the headlines suggested. The economy added 130,000 jobs in January, double expectations. Friday's CPI showed inflation cooling more than expected, with core CPI rising at the slowest annual rate since December 2021. The combined picture keeps rates steady through the end of Jay Powell's tenure.
I expect this environment of relatively strong growth, boosted by higher tax refunds from the One Big Beautiful Bill Act, an improving job market, and continued trending lower inflation to keep interest rates in a steady range as we await Kevin Warsh's fresh perspective at the Fed. Powell's term as chair ends in May, and traders are pricing just over 50% odds of a quarter point cut by June.
This week brings more data context with Friday's PCE report offering a read on consumer spending and inflation. Wednesday's FOMC minutes will be parsed for insights on the last rate decision. The 10 year Treasury yield sits at 4.03%, with traders pricing a 90% chance the Fed holds rates unchanged at the current 3.50-3.75% range.
Market Structure Warning
Some statistics deserve attention. The MSCI USA Index's market cap relative to US M2 money supply is at a record 270%, up 120 percentage points since 2022. This surpasses the 2000 dot-com bubble peak by 40 percentage points and the pre-2008 financial crisis high by 75 percentage points. The market has never run this far ahead of liquidity before.
Volatility beneath the surface is also surging. The spread between average single stock two week volatility and Nasdaq 100 volatility is at 20.7 points, the highest since 2020. This has doubled over the last month, now three times higher than the four-year average. Despite the broad market looking calm, volatility is severe in many parts of this market.
If the market is going to roll over as many have called for, it will have to be the equal-weight index that breaks down. The broadening has helped the market index maintain its footing this year. For a sustained larger move to the downside, the RSP would need to fall meaningfully. I had started to believe this was going to happen towards the end of February, but with the levels of bearish sentiment in the market, the market often surprises you in the those moments. I still think the next major move overall is slightly down.
Final Thought
The S&P 493 outperforming while the Magnificent Seven lag confirms that the bull market is still strengthening despite weaker players at the top. This does not mean the era of mega cap dominance is ending, nor does it make sense to bet on any popping of an AI bubble. But the bull market does appear robust enough to find plenty of magnificence in the rest of the market.
We are witnessing various firms creating lists and baskets of stocks they believe are immune to AI disruption. I expect defensive sector ETFs focused on AI resistant businesses to become a theme in coming months as investors seek shelter from the disruption trade.
The week ahead will be shaped by Walmart's Thursday earnings, a strong indicator of consumer health under new CEO John Furner. Energy names like Constellation Energy, Energy Transfer, and Southern Company will offer signals on how AI's power demand is changing their business. Friday's PCE and University of Michigan sentiment data round out a week that should provide clarity on whether consumers remain resilient despite market volatility.
Use this dislocation to position for the themes that continue working: small caps, international diversification, equal-weight strategies, and selectively adding quality tech names at levels that would have seemed impossible just months ago.
As always, feel free to reach out with questions about positioning for these evolving market dynamics.
Best regards,
Dan Sheehan [email protected]
Subscribe: https://substack.com/@dansheehan3
This newsletter is for informational purposes only and should not be considered as investment advice. Please consult with your financial advisor about your specific situation.