Analysts at Morgan Stanley say the rapid rollout of new artificial intelligence models poses “structural risks” to equity markets, but they also point to several “contradictory elements” within the broader AI-driven disruption story.
Shares across the global software sector have come under pressure in recent weeks, as investors react to the launch of advanced AI tools capable of replicating or enhancing services traditionally offered by listed companies.
The weakness has extended beyond software, affecting industries ranging from data analytics to logistics and real estate, amid concerns on Wall Street about the far-reaching implications of AI adoption.
Since January 28, the tech-focused Nasdaq Composite has fallen more than 5%, while the so-called Magnificent Seven group of mega-cap technology stocks has dropped over 8%. Market heavyweights Microsoft (NASDAQ:MSFT) and Amazon (NASDAQ:AMZN) have declined 17% and 18%, respectively, amid questions about the returns on substantial hyperscaler investment in AI infrastructure.
In a research note, analysts including Michael Wilson and Andrew Pauker highlighted what they described as “contradictory elements” in the prevailing AI narrative, particularly “in the sense that they all seem to be in focus at the same time.”
“For instance, if AI is going to be highly disruptive and far-reaching in terms of its effectiveness, doesn’t that support the investment case for the infrastructure/compute enablers, especially since the market is broadly rewarding high capex/sales, cost of capital is contained, cost of compute is still elevated, and valuation has not expanded since ’23 for the mega cap enablers?” the analysts wrote.
“Further, if AI adoption is likely to lead to more job loss, isn’t there a phase-in period where natural attrition isn’t replaced, efficiencies are realized and margins expand?”
They added that near-term volatility may persist as the economic cycle enters what they termed a “weak seasonal window” and liquidity “remains tight.” However, they noted that a broadening of earnings growth is supporting capital rotation into cyclical stocks.
Given this backdrop, the analysts expressed a preference for the S&P 600 Small Cap Index over the Russell 2000, arguing that it offers higher quality exposure and less sensitivity to speculative growth segments. They also favor large-cap healthcare stocks as a form of “defensive exposure” against potential market swings.
On a stock-specific basis, the team sees “attractive entry points” in software names such as Palo Alto Networks (NASDAQ:PANW) and Intuit (NASDAQ:INTU), alongside business services and real estate-related firms including S&P Global, TransUnion, and CBRE Group.