AI rotation: Chip ETF's 80% run stalls, money moves to software

AI chip stocks are cooling as money rotates into software, with the iShares Semiconductor ETF down double digits over seven weeks after an 80 percent year-to-date surge.

Goldman Sachs traders described overall activity as muted, with total market volume running about 12 percent below its five-day average. Hedge funds showed a modest buying bias, adding semiconductor and telecommunications exposure while reducing software positions.

The iShares Expanded Tech-Software Sector ETF, which tracks 106 software stocks including Palo Alto Networks, Microsoft, and Palantir Technologies, gained a double-digit percentage during the same seven-week stretch. Intel now trades at 79 times forward earnings after its shares soared more than 170 percent year to date, while Nvidia's forward earnings multiple sits at 22.9 with a PEG ratio of 0.55.

The rotation reflects investors shifting attention to companies that will use AI to generate revenue rather than those making the hardware required to run AI applications. Software-as-a-service stocks were sold heavily earlier this year on fears that AI would disrupt their business models, leaving many trading at historically low valuations.

The divergence between the two iShares ETFs is stark. SOXX owns 30 semiconductor stocks and is up roughly 80 percent year to date, but has fallen by a double-digit percentage over the last seven weeks. IGV has risen by a double-digit percentage during the same period.

The S&P 500 has gained 0.62 percent year to date, with three of the five top-performing stocks in the index being semiconductor names. But the recent rotation suggests investors are becoming more selective about which AI plays deserve premium valuations.

Cash in the chips?

Some investors may be tempted to take profits on semiconductor stocks to join the rotation. But that could be a mistake. Many AI chip stocks continue to deliver exceptional earnings growth, and demand from data centers hosting AI systems shows no signs of waning.

While some chip stocks are priced at a premium, others still offer attractive valuations. Nvidia's forward earnings multiple of 22.9 with a PEG ratio of 0.55 based on five-year growth projections suggests the stock remains reasonably valued despite its massive run. Intel's 79 times forward earnings multiple, by contrast, reflects the market pricing in a dramatic recovery after its shares more than doubled this year.

The valuation gap between the two groups is also notable. SaaS stocks were sold off aggressively on fears that AI would replace traditional software business models, a dynamic some have dubbed the "SaaSpocalypse." That selloff has left many software names trading at historically low multiples, making them attractive to investors looking for AI exposure at more reasonable prices.

Cross-asset context

The rotation comes as broader market conditions tighten. The 10-year Treasury yield sits at 4.672 percent, near the top of its post-2010 range, while Brent crude trades above $83 per barrel after Iran proposed restrictive conditions for Strait of Hormuz passage. The dollar index stands at 99.83, and gold briefly traded above $4,300 per ounce before retreating.

Memory stocks have been the clearest pressure point, with Sandisk and Western Digital falling after their forecasts disappointed investors. The S&P 500 excluding major AI beneficiaries finished in the red, suggesting the AI trade is narrowing.

Credit markets are sending a mixed signal. High-yield spreads sit near the tightest levels of their historical range, yet the price of protection against a broad credit event is close to a historical extreme, with five-year high-yield base correlation near the 99th percentile.

It's probably too soon to know if the rotation from chip stocks to software stocks has legs. The recent trajectories for each group could reverse in the coming weeks. Investors could be better off playing both sides of the AI trade by holding both the iShares Semiconductor ETF and the iShares Expanded Tech-Software ETF.

This article is for informational purposes only and does not constitute investment advice.