Teresa Rivas

Humans are storytellers at heart. From recognizing patterns to imparting morality, telling tales proved to be an evolutionary advantage, and spinning yarns around a campfire is as old as language itself.

Unfortunately, stories can also get us into trouble when it comes to the stock market. "Every bubble in modern market history has been based on a narrative, whether it be the internet or real estate," writes Sevens Report President Tom Essaye. Today of course, the theme is artificial intelligence. So the question is whether investors are correctly judging its transformative power across sectors -- or expectations are getting too far ahead of reality.

Essaye thinks there are a few ways to get an idea. Although hindsight is 20/20, there were clues before previous bubbles popped, like the rising mortgage delinquencies of 2006 and 2007, and the frenzied retail trader volumes heading into 2000. That leads him to believe that the canaries in the coal mines for AI is likely chip makers.

Nvidia is already broadly seen as a proxy for the AI industry, so "if we were to look to Nvidia shares alone as our preferred proxy for the health of the AI trade, then the dream is alive and well and stocks should be set to continue higher as the stock just hit another all-time high yesterday," he writes.

However a single stock, no matter how dominant in its industry, is a poor sample size. However looking at an index like the PHLX Semiconductor Index, or SOX, which tracks Nvidia, and other major players such as Advanced Micro Devices, Qualcomm, Micron Technology, Broadcom, and Marvell Technology, presents a much less sunny picture, as it hasn't hit a new high since July 2024, even as the S&P 500 has risen by a double-digit percentage since on multiple record closes.

"That divergence in index performance is meaningful, and if we see the SOX roll over in the weeks or months ahead and start selling off materially, the S&P 500 will almost certainly not be far behind," Essaye warns.

That said, he emphasizes that this isn't definitive proof that the rally is over. Nonetheless, if chips in general are an accurate leading indicator, "then there is a significant sense of complacency in equity markets right now with risks of a downturn both underappreciated, and more importantly, underpriced in these early stages of the second half."

Plenty of analysts have argued that we're far from bubble territory, as strong fundamentals underpin high valuations. However, other strategists have also pointed to softness among semiconductors recently, and that in a market that might muddle through more than anything else through the end of the year, taking some profits or getting a little more defensive isn't the worst idea.

Of course investors have so far been rewarded for letting their bets ride, despite volatility. If nothing else, they'll likely have an interesting story to tell.

Write to Teresa Rivas at teresa.rivas@barrons.com

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August 01, 2025 12:46 ET (16:46 GMT)

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