Can a rate cut promise overcome Tech’s wobbles?

Last week I reiterated concerns about the narrowness of technology leadership. During the week, the market wobbled as it underwent a violent rotation when technology leaders fell sharply. The sector violated a rising trend line and it’s now testing a key relative support level. The weakness was only a matter of time, as relative breadth indicators (bottom two panels) had been deteriorating for several months.

On the other hand, the stock market adopted a risk-on tone after Fed Chair Powell opened the door to a September rate cut by shifting the focus to the Fed’s employment mandate: “Downside risks to employment are rising. And if those risks materialize, they can do so quickly in the form of sharply higher layoffs and rising unemployment.” Stock, bonds and gold prices soared and the USD fell after his remarks. Was the tech wobble just a market hiccup?

The warnings were plain to see. The Verge reported that OpenAI CEO Sam Altman said the quiet part out loud: Artificial intelligence could be in a bubble comparable to the dot-com era of the late 1990s. Altman was quoted as saying: “When bubbles happen, smart people get overexcited about a kernel of truth…Are we in a phase where investors as a whole are overexcited about AI? My opinion is yes. Is AI the most important thing to happen in a very long time? My opinion is also yes.”

One of the appealing qualities of the technology sector is its capital-light characteristics, unlike the more traditional industrial companies that require a lot of investment in plant and equipment. A common theme that emerged during the dot-com bubble and the AI boom today is their unbelievable capital expenditure levels. The accompanying charts from BCA Research tells the story of the parabolic investment trends, then and now. As the chart of capital spending during the dot-com is shown in dollars, and the one today is shown as a percentage of GDP, my own estimate of the peak capital spending of the dot-com bubble indicates a peak of about 1.1% of GDP, which is slightly less than the levels today (chart annotation is mine).
 

 

The parabolic growth in capital spending is occurring against a backdrop of diminishing returns from large language models (LLMs). If progress starts to stall, it could affect market sentiment.

 

As well, AI adoption appears to be hitting some roadblocks. A Census Bureau survey shows that using AI in last two weeks fell to 8.8%, the lowest since May.

 

A recently published MIT study, “The GenAI Divide: State of AI in Business 2025”, found that 95% of AI pilot programs are failing. A Fortune article explains the problem as workflow integration:

The core issue? Not the quality of the AI models, but the “learning gap” for both tools and organizations. While executives often blame regulation or model performance, MIT’s research points to flawed enterprise integration. Generic tools like ChatGPT excel for individuals because of their flexibility, but they stall in enterprise use since they don’t learn from or adapt to workflows, Challapally explained.
The data also reveals a misalignment in resource allocation. More than half of generative AI budgets are devoted to sales and marketing tools, yet MIT found the biggest ROI in back-office automation—eliminating business process outsourcing, cutting external agency costs, and streamlining operations.

 

By implication, the much touted mass layoff effect from AI adoption is far in the future.
 

 

Constructive Signs

Here is the good news, even as large-cap technology stocks falter, the rest of the market is holding up well on a relative basis. The equal-weighted S&P 500 broke out on Friday to an all-time high, and the percentage of stocks above their 200 dma rose a new recovery high, indicating strong participation.
 

 

Equally encouraging are the absolute and relative upside breakouts exhibited by the small-cap Russell 2000.
 

 

As well, these before and after Powell speech snapshots of Fed Funds expectations summarizes how the market consensus has shifted. The odds of a September rate cut rose from 71.5% to over 90%. The market still expects two quarter-point rate cuts in 2025, and an accelerated easing schedule in 2026.
 

 

 

No Major Top in Sight

From a big picture perspective, I see few signs of a major market top despite the tech wobble. In a surprising turn of events, well-known value investor Howard Marks appeared on Bloomberg TV and acknowledged that U.S. stocks are in the “early days of a bubble”, but he is not “ringing the alarm bells” of a “serious market correction”. He compared current conditions to 1997 when Greenspan warned about irrational exuberance, but stock prices continued to rise for several years.

Jim Paulsen studied the variance from the long-term of different investment styles. While large-cap growth is highly extended, he found that the rest of the market is not, which is constructive for long-term equity returns.
 

 

In addition, consumer confidence is low by historical standards, which tends to be bullish for equity returns.
 

 

 

Short-Term Warnings

Nevertheless, I am tactically cautious on stock prices. Most of the improvement in breadth indicators can be attributed to the single-day reaction to Powell’s speech, and I would prefer to see bullish confirmation before becoming overly bullish. As a reminder, the market had been hesitant until the Powell speech as the S&P 500 declined for five straight days. Even as the S&P 500 tests overhead resistance, it’s exhibiting negative RSI divergences. And even though the VIX Index fell to test its lows, the VVIX, which is the volatility of the VIX, exhibited a divergence by staying at elevated levels.

 

As well, the July FOMC minutes showed that, were it not for the extreme weakness in the Payroll Report, most of the Committee believed that a September rate cut would be highly doubtful. In his Jackson Hole speech, Powell adopted the Waller view that tariff-induced inflation is probably a one-time shock and labour market weakness can’t be ignored.

Bloomberg’s NLP Fedspeak Index, which is derived from a chatbot, interpreted recent Fed speeches as having hawkish tones. While the opinion of the Fed Chair undoubtedly carries a lot of weight, this is a sign that the FOMC is divided. The market consensus is highly fragile, and even slight shifts in the data, such as a hot PCE print or strong NFP report, could quickly shift expectations in the opposite direction.
 

 

Based on the recent record of weakness of initial jobless claims (red lines, inverted scale), the odds of a positive July nonfarm payroll surprise are elevated, which would completely flip the narrative and market expectations.
 

 

From a trader’s perspective, banking system liquidity is weak, which creates a headwind for stock prices. Recent Treasury’s debt sales were supported by a decline in ON RRP, which is now almost empty. Further debt issuance will drain market liquidity.
 

 

Investors should be on guard for heightened levels of volatility. Nautilus Research pointed out that we are entering a period of positive seasonality for the VIX. As the S&P 500 tends to be inversely correlated with the VIX, investors should pay special attention to developments in volatility during this seasonally important period.
 

 

In conclusion, recent stock market leadership had become overly concentrated in large-cap technology stocks, which wobbled last week. The good news is market breadth is broadening out, which sets the tone for further price advances. However, weakening liquidity and negative seasonality pose short-term risks to the current uptrend.