UBS Group AG's trading division suggests the sharp sell-off in momentum stocks may be nearing its end, potentially creating an opportunity for investors to rebuild positions in artificial intelligence and semiconductor shares.

According to data from UBS Group AG's prime brokerage, hedge funds have already begun unwinding long positions in momentum and semiconductor stocks, with reductions amounting to approximately 5% of total market value, marking one of the largest recorded pullbacks. This has brought net positioning in semiconductor and software stocks back to levels seen in April.

Michael Romano, head of hedge fund equity derivatives sales at UBS Group AG, noted in a client report that despite the recent pullback, improving fundamentals for AI serve as a signal to buy on the dip. However, he advises investors to build positions gradually rather than committing fully in one move. Momentum strategies involve purchasing top-performing stocks while shorting those with the steepest declines.

Romano wrote, "Momentum de-risking was and remains my strong conviction. A phased entry is the prudent approach."

The momentum stock basket highlighted by UBS Group AG includes companies such as SanDisk, Broadcom, Oracle, KKR & Co. Inc., Datadog, and Microsoft.

Romano pointed out that current positioning is increasingly favorable for a rebound in such stocks. However, a recovery in AI and momentum shares might come at the expense of recent market leaders. Data from UBS Group AG's prime brokerage indicates that much of the recent buying in banks, industrials, and other cyclical stocks reflects short covering rather than new long positions, suggesting these sectors could see a pullback as investors rotate back toward AI-related stocks.