Whether or not luck is really better than luck, it’s definitely best to have both when possible. The S&P 500’s steep 1.3% rise in the first five weeks of this year reflects a lot of good fortune, while certainly demonstrating the remarkable resilience of risk-seeking capital to continue participating in the stock market. It’s a bit of luck that the collective mini-panic over AI’s disruptive downside occurred during one of its best seasonal periods, with three big profit increases in a year followed by an unusually large net investor inflow. Similarly fortunately, fiscal taps are wide open everywhere, supporting high nominal growth around the world, while last year’s tax reform in the United States should reduce real GDP by almost a percentage point. Also, while most economic indicators are starting to rise, only the labor market appears to be stagnating, and with the Fed becoming more dovish given the overall pace of growth, could it also be a convenient break for markets rather than workers? This combination of fitness and luck has driven an aggressive and fast rotation within the market, which has (so far) succeeded in extending its leadership and awakening long-dormant sectors, while the top-tier S&P 500, although supported, has languished just below the 7000 mark since late October. The tagline for this rotation is “Out with the new, in with the old.” The year-to-date performance of the major indexes follows the chronology of their inventions. The Dow Jones Industrial Average rose 4.3%, the S&P 500 rose 1.3% and the Nasdaq Composite Index fell 0.9%. Investors are selling 21st century “innovators” to buy 19th century companies. They are in a hurry to retreat from technology. A company’s competitive advantage is a line of code that fits on a thumb drive, allowing companies to mass produce assets of scarce physical necessity. Caterpillar vs. Microsoft Friday’s path to the Dow’s closing price above 50,000 for the first time illustrates this story well. The venerable but notoriously eccentric price-weighted index has added 2,052 points so far this year. Caterpillar, the maker of huge machinery, including the generators needed for AI data centers, alone contributed 985 points to the Dow Jones Industrial Average. That’s about the same number of points that the declines in software giants Microsoft (529) and Salesforce (472) have cost the Dow Jones Industrial Average this year. Energy will be the top sector on the S&P 500 in 2026, as John D. Rockefeller is cheering you on. The rail group as a whole has risen 13% in the past two weeks. The agricultural products subsector of the S&P 500 Basic Materials sector, comprised of Bunge Co. (founded in 1818) and Archer Daniels Midland Co. (founded in 1902 by two men born in the 1850s), is up 19.8% since Dec. 31. To a large group of investors who have spent the last three years working together, this all looks very healthy, healthy and refreshing. They lament that market value is increasingly concentrated in a small group of big tech platforms chasing AI. And, all else being equal, it’s positive to see the index rebalancing nicely as money moves into a reflationary cyclical theme. Such concerns surround how much growth and valuation support the old economy sector can provide going forward. A related but separate issue is the extreme internal market positioning and volatility that is being created by the frenzy of moves in and out of various sectors and investment factors (momentum, value, beta, earnings corrections, etc.). First, notice that large-cap value stocks don’t look cheap. The S&P 500 Value ETF (IVE)’s forward price/earnings ratio exceeded 19x for the first time in memory. Probably the first time outside of a recession where profits have collapsed. Indeed, expanding valuations is probably the market’s way of anticipating earnings acceleration that exceed analysts’ expectations. Therefore, as long as earnings continue to exceed expectations, there may not be much to recover in the short term. But that at least means that value growth cannot be said to be an undiscovered opportunity. Looking a little closer, as of about two weeks ago, the S&P Industrials sector had a higher valuation than Technology, which has only happened a few times over short periods of time in recent decades. Again, this is the market’s way of moving from sectors with too much production capacity facing oversupply (software creation can be done cheaply and infinitely with AI) to sectors with multi-year production constraints (gas turbines, jet engines, electrical equipment). Deutsche Bank strategists on Friday warned of a ferocious flow of investor money into non-tech sector funds to fulfill a long-promised and ongoing rotation, saying: Inflows into sector funds hit a record $62 billion in the first five weeks of the year. For context, this is more than we saw in all of 2025 (just over $50 billion) compared to normal rates.” Historically, year-to-date inflows have been nearly four standard deviations above average. ” Meanwhile, outflows from both software and cryptocurrencies (the asset class most correlated with unprofitable tech stocks) have increased excessively, and on Thursday, the ferocious sell-off in software and Bitcoin reached an extreme, with money pouring in to catch the falling knife. Software Washout Given the stereotypes of the sector’s investor base, software was uniquely vulnerable to any perceived threat from AI. Software-as-a-Service is built to Wall Street specifications as a subscription business embedded in critical business and consumer processes, and its annual recurring revenue stream will last for decades. Oh, and if SAAS companies underperformed at all, they were seen as ideal to be taken private by acquiring companies that preferred long-term cash flow to pay off debt. Right now, private capital stocks are tanking due to software exposure (rightly or wrongly, this certainly reduces the cushion for “LBO bidding”). Many of the big software platforms (such as Salesforce, which currently trades at a P/E of less than 15x, and ServiceNow, which boasts an all-time high free cash flow yield of 5%) have decent arguments against the bears. But as Tony Pasquariello, head of hedge funds at Goldman Sachs, said in a weekend market dispatch, “The question is whether this group can convince investors that the problem is not as fundamental as the recent downgrades suggest…Once the market decides that something has structurally changed, it becomes increasingly difficult to break through that perception (witness traditional media and brick-and-mortar retail).” The combination of massive overselling in high-tech components and panic buying in some non-tech sectors (Walmart soars to 43x forward earnings) has reached an extreme situation playing out across asset markets. These include a never-before-seen outperformance in semiconductors versus software, the US dollar near a four-year low, and multi-decade highs in silver prices relative to gold. Barclays’ tactical equity strategy desk said that in the 10 days leading up to Friday’s rally, internal market whiplash (measured as realized volatility between major investment components) reached an extreme that had only been seen around last year’s Liberation Day panic, at the peak of the 2022 rate hike/recession scare, and during the coronavirus crash. Still, the S&P 500 itself was down less than 3%, and the CBOE S&P 500 Volatility Index (VIX) only briefly rose toward 23 before falling later in the week. “Importantly, the market effectively ‘crashed’ without a single drawdown due to the typical symptomatic correlation,” Barclays said. Sounds like a lucky vacation. Will investors be able to stay lucky? That is, assuming last week’s emergency momentum reversal action is over. Whenever such an emergency hedge fund derisking event occurs, brokerages try to handicap how much repositioning will be needed to return posture to neutral footing, similar to how various hurricane models try to predict the path of a storm. Last year, a similar episode triggered by DeepSeek’s potential threat to U.S. AI companies caused the iShares Momentum ETF to tank compared to the S&P 500 Low Volatility Basket. This decline was quickly reversed within a week and further new highs were achieved before another momentum positioning shock occurred in mid-February. All of this is to provide context for a confident prediction that the current rotational trend could proceed harmlessly from here. February doesn’t have to be a tough month, but after strong previous years in 2018, 2020, 2021, and 2024, a notable tactical peak in the high-momentum part of the market occurred. The S&P 500 has been stymied in every attempt to overcome its late-October high, and the Vanguard Total Stock Market Fund has been flat over the past two months, with seasonal factors helping and profits continuing to rise. Still, these increases in revenue mean that overall market valuations have declined since October. Other parts of the world have also been of great help. In the fourth quarter, S&P 500 companies with at least half of their revenue coming from overseas had an average growth rate of 17.7%, compared to 10% for companies with at least 50% domestic sales, according to FactSet. With a ferocious capital spending boom, record corporate profits and a federal deficit of nearly 6% of GDP, the economy is in deep trouble. So far, Treasury yields have been subdued and public company debt spreads have remained static. There’s certainly a lot of good going on, but it’s worth asking how much is priced in, and how long the market can continue to avoid unfortunate breaks.
