One or more of three things can happen when the market is finished rotating through all the possible beneficiaries, direct and indirect, from a given powerful positive economic force. The market can:

–begin the whole process of revaluing upward all the winners from the current theme. In the case of AI, this would probably start with a revaluation of Nvidia,

–move on to another big idea. This could be, for example, export-oriented manufacturing, or reignition of consumer spending or…

–assume a defensive posture and begin to sell off–beginning what market watchers euphemistically call a “correction”–on the belief that there’s nothing with significant upside potential left to buy at today’s prices.

I’m writing this about 15 minutes after the New York market open. Although one can’t put very much weight on the message from very short-term indicators, a reasonable (to me, anyway) guess is that this morning’s winners will give a useful picture of what a correction might look like.

One, probably too simple, way of looking at market rotation is that one group of stocks, for whatever reason, goes up sharply while other sectors languish. At some point, the valuation difference between the to-date winners and losers becomes so great that investors switch from the now-expensive stocks to the too-cheap.

In today’s US market, on the other hand, it has been all tech, all the time. Over the past year, for example, the IT sector is +54.5%. Ex IT, the S&P 500 is ahead by +18.1%. So far this year, IT is +20.1%. Ex IT, the S&P is +4.4%.

Micron (MU), a memory chip maker, has more than tripled since January 1. It was up by just under 20% yesterday, on news of a sharply upwardly revised brokerage house earnings estimate for this year. It’s ahead by almost 10% in the pre-market, as I’m writing this (I own shares of MU and have been scaling back recently, because the position has gotten bigger than I feel comfortable with).

On the other hand, consider Nvidia (NVDA), which is the leading light in the AI chip market. It is up so far this year, but only by about +15%. That’s better than the S&P’s +9.8%, but not by that much–and less than the IT sector as a whole.

My interpretation:

–there is rotation in the US market, but it’s either within the tech sector or from domestic tech to non-US companies

–the rotation away from NVDA is based on relative valuation and on two company-specific factors: Washington’s restrictions on exports and the loss of operating leverage as salaries shrink as a portion of operating expenses. (I’ve recently bought back some of the NVDA I sold last year (to rotate into AVGO, which I have since sold), on the idea that NVDA is now a closed-end investment company).

–the other rotation I see is from the US to the rest of the world, because even typically meh eps growth prospects there are better than we can expect from the US.

what it is

“Rotation” is the term the stock market uses to describe the process of shifting portfolio holdings from one group of stocks to another in search of higher potential returns.

rotation patterns

There are a number of drivers that influence the rotation process:

—the business cycle, which is probably the most important and far-reaching. In its simplest form, the idea is that national central banks attempt to create maximum sustainable GDP growth by using short-term interest rates to either accelerate the rate of growth by lowering the Fed Funds (short-term) interest rate or to retard too rapid growth by raising it. Professional investors typically shift their holdings in accord with, or in anticipation of, central bank actions–to emphasize sectors and individual stocks that benefit from consumer spending as they perceive that rates are about to fall, and into defensive sectors like utilities or consumer staples when they conclude that rates are about to rise.

—an industry-specific wave. One of my early mentors once explained his investment process like this:

let’s assume the government announces a national road-building program. Some people will buy the road construction stocks, others will buy the cement plants. I buy the makers of cement trucks. His idea was that if there are only one or two companies in the country that make cement trucks, both are sure to benefit. Trucks are also far enough back in the chain of beneficiaries that their stock prices are unlikely to have risen already to reflect the upcoming surge in orders. It’s also possible that not that many people are thinking that far ahead, so that the positive surprise will be BIG when the company begins to report accelerating earnings gains. And, again because cement truck sales aren’t typically glamorous, and therefore front of mind, the stocks are likely to be very cheap.

There’s at least one other way to approach this, though. You start by buying construction companies, then shift (rotate) into cement plants as construction company stocks begin to get pricey …and when plants move up, only then into trucks. This is rotation.

An important note: when the market gets to the point of bidding up cement truck makers, we’ve reached pretty much the end of the line. One of two things will happen: either the market will return to the original, most obvious beneficiaries, the construction stocks, and start another round of bidding prices up or, just as likely, the party’s over and the market moves on to other areas. Either way, this is another important feature of rotation patterns. They should force us to think about how much more outperformance is left in the stocks we hold. My rule has been that the tinier, niche-ier, funkier the stocks I’m holding are, the closer the end of the movement is.

the main classic rotation today: AI hardware

Over the past year or so, AI hardware relative performance has followed the typical rotational pattern:

—–first, Nvidia, the pure play on AI chips,

—–then to Broadcom et al, who build AI installations that use AI chips,

—–then to Micron, Samsung Electronics and Hynix, which make DRAM that are adjuncts to AI chips, and

—–now to Credo, Wolfspeed (yes, it was recently in Chaper 11, but I like the name), Cerebras and other lesser-known firms, that make doodads that do things like control the heat in AI centers. I see these as the AI equivalent of the cement trucks. The current dilemma for early-in, early-out investors, I think, is that although they might like to rotate away from tech into something else, there’s no other obvious place to go in the US market.

I sold my NVDA, which I’d held for several years, last summer, because its operating leverage was disappearing, and rolled into the other names in the order above. I bought NVDA back recently on the idea that it’s now morphed itself into being a closed-end investment company, and provides low-beta exposure to the overall industry.

other kinds of rotation

–in my first full-time portfolio manager job, my office was right next to the firm’s most successful portfolio manager. The organization set conservative goals for us–bonuses maxed out at outperforming the benchmark index by 1 percentage point, and disappeared entirely if the portfolio didn’t at least match the index. My colleague typically broke through the 1% target before midyear. As soon as he did so, he “derisked” his portfolio by making it look just like the index and basically coasted for the rest of the year. The following January, he’d reset. Another, though infrequently used, reason for portfolio rotation.

–home market vs. foreign stocks. There were several seismic events in the world during the closing decades of the last century: the revaluation of the Japanese yen, which caused a massive surge in domestic-oriented stocks; China declining to renew the UK lease of Hong Kong, which refocused world attention to mainland stocks; and the formation of the euro, which triggered a huge M&A wave in anticipation of the Common Market.

Since the turn of the century, however, world equity attention has focused almost exclusively on the US, with domestic portfolio managers having no reason not to stay at home. The current administration’s economic plan, however, has revived interest in EAFE stocks, which since the inauguration and until relatively recently have steadily outperformed the S&P 500, despite AI being the largest single area the S&P is exposed to.

WMT reported earnings for 1Q27 yesterday, and the stock dropped 7% on the news (note: I own WMT shares in the only fund I actively manage; I’m also a Walmart+ member). To me, the negative reaction was more about the company’s projections for the rest of the year than anything else. What struck me from the conference call:

–although I hadn’t thought about it much, I was surprised at the amount of customer information the company must be collecting to be able to make the statements it did

–for example, the company’s sales gains are in large part coming more from higher-income consumers trading down from traditional supermarkets to WMT than from its traditional customer base

–lots of customers were availing themselves of WMT’s relatively cheap gasoline, but for the first time in years, lower income customers weren’t filling their tanks–because, I assume, they didn’t have enough money to

–income tax returns were higher than usual this year, however, so customers had more than they’ll presumably have to spend during the rest of the year

–not stated, but implied, most of the sales gains came from more affluent customers either trading down for the first time or expanding their use of WMT offerings

–also not stated, but my conclusion, strength in non-US businesses is helping to offset weakness at home

All in all, the message I get is that, looking from the ground up, the message is the same: the administration has made the US an increasingly difficult place to do business in, with the worst economic damage is being done to ordinary people.

Two things struck me from the Opinion page:

–“The only thing that is novel about Trump’s Iran war is the immediate obviousness of its bankruptcy.” Basically, as the FTs US chief correspondent sees it, this is the LBJ Vietnam playbook, as well as Bush’s in Iraq–administrations dazzled by US military might, but with no understanding of the political/social situation in the countries we attacked. Look how those worked out.

–“The Gulf crisis may just be starting” writes the FT’s chief economist, and may morph into the “biggest energy crisis in history.” The main premise is that the world’s overall demand for oil is relatively inflexible. While the Trump blockade may ultimately succeed (if that’s the right word), it could easily trigger higher inflation, higher interest rates and recession before reaching its end goal.

If any of this is close to the mark, we as stock market investors may soon have more to worry about than the pecking order within the tech sector. I hope not, but will the gigantic clown car that Washington has become figure things out in time?