A trading desk at Morgan Stanley posits that market fears regarding artificial intelligence disrupting traditional industries may have reached their zenith. For investors who remain concerned about the ongoing impact of AI, a strategy focusing on physical assets characterized by high barriers to entry and low susceptibility to technological obsolescence—termed the "HALO" trade—is presented as the optimal hedging approach currently available.

A recent catalyst for shifting market sentiment was a briefing on Enterprise Agents by AI firm Anthropic. Contrary to prior market anxieties that AI would entirely replace existing software vendors, the event signaled a greater inclination towards "collaboration" rather than "substitution." This rapid reassessment of expectations directly triggered a relief rally in software stocks, which had been heavily shorted.

Prior to this turning point, apprehension about AI's disruptive potential had already significantly impacted internal market dynamics. Although the S&P 500 index remained relatively stable overall since late October, extreme capital flows from hedge funds resulted in unprecedented divergence within the index. Funds aggressively poured into AI beneficiaries and the semiconductor sector while indiscriminately selling off software assets.

While initial buying interest has begun to emerge in the software sector, Wall Street institutions note that if the "AI fear" has not completely subsided, a fundamental shift in the core pricing logic of the stock market is underway. Market capital is accelerating its transition from narratives centered on "scalable, asset-light" models towards "buildable, hard-to-replace physical capacity and networks."

Beneath a seemingly calm market surface, extreme divergence and rotation have occurred. Against a backdrop of marginally looser macro-financial conditions, the stock market has experienced intense internal adjustments. Morgan Stanley trader Kunal Sodha pointed out that while the cash level of the S&P 500 has barely changed since late October, the past four months have seen significant corrections within the equity market, with index divergence reaching unprecedented levels.

Data illustrates the extremity of this rotation. During this period, the performance spread between growth and value stocks experienced a 24% drawdown, a Beta long-short portfolio saw a 21% drawdown, and the S&P 500's Information Technology and Consumer Discretionary sectors also fell by 11%. This adjustment, occurring without negative macro shocks, was entirely driven by escalating "AI disruption panic," ultimately contributing to IBM's stock recording its second-largest single-day decline this century, excluding the dot-com bubble burst.

However, the broader index managed to maintain a sideways trend because capital quickly flowed into defensive and cyclical sectors. During this time, the Industrials sector rose 13%, Consumer Staples gained 16%, Materials advanced 22%, and the Energy sector surged 25%. Looking at quarterly returns since 2021, the performance spread between the best and worst-performing sectors in the S&P 500 this quarter has reached the third-highest level since 2021.

Hedge fund flows further exacerbated the extreme positioning in the market. Data from Morgan Stanley's Prime Brokerage indicates that this year, hedge funds have been net buyers of semiconductors and full-stack AI assets, pushing exposure in these areas to its highest level since 2020. On the flip side, Morgan Stanley's Infrastructure Software basket became the most sold thematic this year, with its positioning collapsing to the 0th percentile since 2020.

However, this trade based on extreme positioning faced a reassessment following the Anthropic briefing. Goldman Sachs noted that the market interpreted Anthropic's developments as signaling "collaboration" with existing SaaS providers rather than "replacement," triggering short covering in the software sector. Stocks previously categorized as "facing AI risk" rebounded by approximately 5%.

Deutsche Bank expressed a more optimistic view. The bank believes model providers are unlikely to replace existing software giants and are instead more inclined to position themselves as an orchestration layer on top of existing systems. Since data and workflows reside within established systems of record, the knowledge and metadata accumulated by these systems are exceedingly difficult to replicate or replace.

For investors who believe "AI fear" has not yet peaked, Morgan Stanley offers a clear trading recommendation: embrace the HALO theme. HALO is an acronym for "Heavy Assets, Low Obsolescence." This concept has now been widely adopted by several Wall Street investment banks, including Morgan Stanley, Goldman Sachs, and JPMorgan.

As previously reported, a Goldman Sachs report from February 24th argued that amid a combination of higher real interest rates, geopolitical fragmentation, supply chain restructuring, and an AI capital expenditure wave, the market is undergoing a "re-pricing of scarcity." Market leadership is returning to tangible productive assets, with the market beginning to reward capacity, networks, infrastructure, and engineering complexity, as these assets have extremely high replication costs and are not easily rendered obsolete by technological iteration.

The economic relevance of these assets endures across technology cycles. Whether it's transnational oil pipelines or national power grids, they cannot be easily replaced by code or digital innovation. Morgan Stanley's HALO basket is constructed based on this logic, encompassing seven structural pillars: Materials, Utilities, Railroads, Pipelines, Waste Management, Defense, and Communication Towers.

From a performance and valuation perspective, this strategy shows significant appeal. Over the past year, Morgan Stanley's HALO basket has risen 28%, while a basket of stocks deemed "vulnerable to AI disruption" has fallen 43%. Furthermore, positioning in the HALO sector is not crowded, with net exposure since 2020 only at the 53rd percentile. A Morgan Stanley trader suggested investors can position themselves by purchasing 6-month 110% call options on the MSXXHALO basket, with an indicative cost of just 2.5%.