How We Can Trade AI Software Stocks As Market Rotate Out Of AI Chips?

Investors have long view the semiconductor sector as a leader in market performance in recent years, but we have seen it faced significant headwinds in recent months, especially after mid-October.

After semiconductor sector did an impressive run in 2023 and through most of first half of 2024, we saw it getting a sharp hit in July when expectations for Fed rate cut grew and also the infamous Japan carry trade unwinding. That period, investors are rotating into more defensive areas in the market.

The reason why I have a mixed of AI software, semiconductor and fintech stocks is because I have been seeing rotation might happen again since July, after I load most of these stocks during August.

So in this article I would like to examine whether the market rotating out of semiconductor have already happen, and how or where we can trade in AI software or other sector like fintech to overcome any impact that might be arising from semiconductor continued downturn?

If we looked at how the benchmark for the semiconductor, VanEck Semiconductor ETF (SMH) dropped from its high at over $280 in July to near the crucial support level of $200 in early August.

This was due sudden selloff that was triggered by investors fears of deeper losses and prompt them to shift into safer sectors like Utilities and Industrials.

Two months later, in October, we saw that SMH ETF has stabilized above critical rising moving averages and pared losses, now sitting just 13.6% below its peak, and we saw a Bull wick appeared, formed a bullish setup, post two consecutive higher lows and consolidating around the $250 level, both close to a potential breakout zone, which we saw two new highs in mid-October above $260 and after the U.S. election.

But since then SMH have traded down below the resistance level around $238, this would raise some concern because if we looked at the previous downside reversal, that could happen fast.

In order to understand SMH performance, we need to understand the top holdings which account for nearly 43% of the ETF’s total weighting.

These are the big names that drive the sector’s performance and hence the ETF, NVIDIA, Taiwan Semiconductor Manufacturing, and Broadcom.

At the end of trading day on Wednesday (27 Nov), SMH lost 1.31% and NVIDIA (NVDA) lost 7.23% over 5 days, Broadcom (AVGO) also declined by 2.19% while Taiwan Semiconductor Manufacturing (TSM) was down 3.81%.

If we looked at the behavior and trading sentiment among the tech investors in the past months, we can see that software stocks especially AI software stocks are preferred while semiconductor makers did not make the list for the tech investors.

The lagged performance of these chipmakers could be understand by the market rotating out of the chip sector, because investors are worried about the stretched valuations and trade war-related risks under Donald Trump. On Monday, we have heard the President-elect which is a vocal critic of the Chips Act vowed to impose additional tariffs on China, Canada and Mexico.

In mitigating the exposure to tariff risks, investors are getting more positive on the AI software group, this is also inline as the tailwind from artificial intelligence looks set to shift from infrastructure to services, which might explain why AI software stocks have been on the upswing.

While there have been lots of good news in the AI chips, but this has also cause the valuation to go higher when there is lots of uncertainty.

One recent example might be Nvidia (NVDA) which post strong results but it has failed to bring up investors confidence and sentiments, Another reason could be chipmakers by being the first major beneficiary of the AI trend has investors begin to see that they look expensive.

Recent earnings reports underline the sentiment shift. Shares in data-analysis software company Snowflake Inc. (SNOW) soared on the back of a robust forecast, while demand for AI software fueled Palantir Technologies Inc.’s blowout report.

So far in November, a major exchange-traded fund that tracks software iShares Expanded Tech-Software Sector ETF (IGV) is up 15.07%, putting it on track for its biggest one-month gain in a year, although it was almost flat on Wednesday (27 Nov) with -0.03%, while we saw SMH lost -3.83% this month.

Flows into the IGV have also far exceeded SMH as seen from the chart below.

So far, the AI theme has benefited chipmakers much more than software firms, with companies pumping money into the chips and servers they need to run the technology. If we looked at Nvidia (NVDA) which might have dropped from its highs despite a positive earnings result, I feel that this stock still have a strong demand as companies both small or large are still investing money into chips and most of them are still using Nvidia GPUs

Meanwhile, only a few software companies, for example, Palantir Technologies (PLTR), Microsoft Corp. (MSFT) and Oracle Corp. (ORCL), they have seen meaningful AI-related tailwinds. But software and services may be the next place that sees an inflection in AI growth.

If we looked at overall growth, semiconductor stocks remain a popular haven for growth. According to Bloomberg Intelligence, earnings for chip companies are expected to grow 40% in 2025, compared with about 12% for those in the software and services industry. Sales growth is also expected to be much stronger for semiconductor firms.

Salesforce has been hiring aggressively to push its new generative AI agent product, and strong results from the company will help sustain the sector’s rally.

So the investing trend for generalist and tech investors have been shifting towards to own much more of software and fintech stocks but own less of semiconductor stocks.

So with a FOMO attitude, we could be seeing investors pushing up the buying for software and fintech stocks.

If we looked at how semiconductors have been performing, though experiencing a downturn, it is not as bad as in July 2023 where we saw PHLX Semiconductor Index (SOX) dropping nearly 7%, marking its worst performance since 2020. ASML Holding (ASML) plunged more than 12%, while Applied Materials (AMAT), Advanced Micro Devices (AMD), Marvell Technology (MRV), and Lam Research (LRCX) all fell more than 10%, and NVIDIA (NVDA) dropped 6.6%.

So the situation now is still not so bad, but as investors we should work towards balancing or reducing the risk by going into or increasing exposure to other sector like AI software or fintech.

We need to do our own due diligence and continue to monitor on how the impact of tariffs on semiconductors would play out.

Appreciate if you could share your thoughts in the comment section whether you think semiconductors rotating out is already happening, it is time to look at AI software stocks.

Disclaimer: The analysis and result presented does not recommend or suggest any investing in the said stock. This is purely for Analysis.