Amid volatility in technology stocks and whispers of rotation toward value sectors, State Street Global Advisors maintains that the artificial intelligence (AI) rally is far from over. The Boston-based asset manager argues that despite intermittent pullbacks, the underlying structure of the AI-driven market remains intact — a function of deep capital expenditure cycles, investor psychology, and the continuing diffusion of AI across industries. The firm’s latest assessment underscores that the AI trade is not a bubble in its final phase, but rather an expanding ecosystem still in its middle innings.

Momentum and Market Psychology Still in Command

For much of 2025, the Nasdaq’s performance has hinged on the fortunes of AI-linked companies. Even after a string of weaker sessions that rattled growth investors, momentum remains the defining feature of the market’s psychology. According to Anna Paglia, State Street’s Chief Business Officer, the enthusiasm is self-reinforcing: investors see AI as a secular force comparable to the internet or cloud revolutions, making it psychologically difficult to step aside. The “fear of missing out” effect keeps funds anchored in the trade, even as valuations stretch.

Paglia notes that investors have been anticipating a rotation toward value for nearly a year, but the evidence simply hasn’t materialized. Despite rising rates, AI-heavy indices continue to dominate fund inflows. The explanation, she suggests, lies in perception: as long as earnings growth in AI remains visible, investors equate short-term corrections with buying opportunities. Institutional behavior supports this view — State Street’s internal allocation data shows institutional clients maintaining overweight positions in technology and communication sectors despite macroeconomic uncertainty.

Behind this resilience lies a powerful structural feedback loop. The leading AI companies — from chipmakers to data infrastructure providers — not only dominate their respective markets but also drive secondary demand across adjacent sectors. Each quarter of strong AI earnings fuels the narrative of inevitability, reinforcing investor confidence that these firms will continue capturing global productivity gains. Until a decisive macro or regulatory shock emerges, State Street contends, the market’s behavioral momentum will continue to sustain the trade.

The Structural Drivers Behind the AI Cycle

State Street’s bullishness does not rest on sentiment alone. The firm points to enduring structural dynamics that underpin the AI economy. First, capital investment in AI infrastructure continues to expand globally. Massive spending on data centers, high-performance computing, and semiconductor fabrication has created a multiyear investment cycle comparable to past industrial transformations. Even if consumer enthusiasm moderates, enterprise deployment — from logistics to finance — is expected to sustain double-digit growth in AI-related spending

Second, AI adoption is diffusing through traditional industries faster than earlier technological waves. Retail, healthcare, and manufacturing firms are all embedding AI into everyday operations, creating an expanding base of recurring revenue for suppliers and software platforms. This real-economy adoption distinguishes the current cycle from speculative tech rallies of the past, where valuations often ran ahead of application. Here, the fundamentals and deployment metrics are converging, not diverging.

Third, AI’s geopolitical and strategic importance continues to attract state-backed investment. Governments in North America, Europe, and Asia view AI as a critical technology for competitiveness and security, providing subsidies, incentives, and research funding. For investors, that means the capital inflow into the sector is not purely cyclical but politically embedded. The result is an unusually durable ecosystem that can weather short-term market corrections. State Street’s interpretation of these drivers leads to a clear message: the AI trade, while volatile, remains in an expansionary phase rather than a speculative one nearing collapse.

The Case for Measured Optimism and Diversification

Despite its optimism, State Street acknowledges that markets are entering a more nuanced stage of the AI cycle. Paglia has suggested that while the momentum remains strong, investors should begin positioning for eventual diversification. The firm’s models show early signs that certain defensive sectors — notably healthcare and industrial automation — are attracting renewed attention. This is not yet a full rotation, but rather a hedging instinct among investors wary of overexposure to one narrative.

The reasoning is pragmatic. Momentum trades can persist longer than expected, but they also compress future returns. State Street advises clients to maintain exposure to AI while gradually adding countercyclical elements to their portfolios. The firm’s multi-sector ETFs are being repositioned accordingly — keeping heavy allocations to large-cap tech leaders while selectively increasing weights in sectors that might benefit from broader digitalization trends. In practical terms, this means using AI-driven profitability to fund diversification, rather than treating diversification as an abandonment of the theme.

Another factor behind this stance is risk management. AI equities have become a large share of major indices, increasing systemic exposure. For long-term investors, balancing that concentration risk is essential even if they believe in the structural story. State Street emphasizes that diversification is not a rejection of AI but a recognition that long-term trends evolve in cycles. The next phase may bring consolidation — a period in which not all AI companies thrive equally, separating sustainable innovators from momentum-dependent players.

Reading the Signals for the Next Phase

For now, State Street argues, it is premature to call an end to the AI trade. The firm is watching specific indicators that could signal a transition. These include a broad slowdown in AI capital expenditure, deterioration in earnings momentum among top semiconductor and cloud providers, or shifts in ETF flows that indicate large-scale rebalancing by institutional investors. None of these have yet appeared in the data. On the contrary, global investment announcements for AI infrastructure continue to grow, suggesting that the hardware backbone of the industry is still expanding.

Still, the firm warns that the story will not remain linear. As AI applications mature, investors may increasingly differentiate between companies generating real revenue from deployment and those surviving on valuation narratives. This bifurcation could create volatility but also opportunity — a phase where stock selection, not blanket exposure, determines returns. State Street’s research desk anticipates that such a phase could arrive in early 2026, when markets begin digesting the true earnings elasticity of AI-driven business models.

For now, the firm maintains its central thesis: the world is still early in a structural transformation driven by artificial intelligence, comparable in scale to industrial digitization or the rise of mobile computing. Betting against this cycle, it says, is betting against productivity itself. The prudent move is not to retreat, but to participate intelligently — recognizing that while valuations may stretch, the foundational economics of AI adoption remain powerful. Until concrete signals suggest otherwise, State Street insists, it is simply too early to bet against the AI trade.

(Adapted from CNBC.com)