From Euphoria to Reality: AI Winners See Sharpest Pullback Since Deepseek
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In the past two years, artificial intelligence has driven some of the most explosive gains across global equity markets. Flagship names in semiconductors, cloud infrastructure, and AI-powered software have soared on the back of investor enthusiasm for what many have called the most transformative technology wave since the internet. Yet over the past several weeks, these so-called “AI winners” have experienced their most pronounced sell-off since what market participants now refer to as the “Deepseek Moment” — a period last year when speculative excess in AI-related stocks abruptly reversed after a highly anticipated product launch fell short of market expectations.
For long-term investors, the recent pullback raises a critical question: is this merely a healthy correction in a multi-decade growth story, or is it symptomatic of a deeper momentum unwind that could persist? In this article, we examine what’s driving the sharp reversal in AI leaders, explain the dynamics of a momentum unwind, and provide an analytical framework to help investors navigate this volatile phase.
A Historic Run Meets Resistance
The rise of AI as an investment theme has been nothing short of spectacular. Since the beginning of 2023, the NASDAQ AI Index surged more than 90% through early 2025, outpacing the broader NASDAQ Composite and S&P 500 by wide margins. Leading chipmakers such as Nvidia, AMD, and Broadcom notched record highs, while software players like Palantir, C3.ai, and even traditional cloud firms such as Microsoft and Amazon enjoyed outsized multiple expansion.
However, in the wake of record quarterly earnings and exuberant forecasts earlier this year, investor expectations became stretched. When Chinese AI firm Deepseek AI unveiled its highly anticipated next-generation language model in March — a product billed as a direct rival to OpenAI’s GPT line — it sparked a classic “sell the news” reaction as investors reassessed the speed of progress and competitive dynamics in the space.
What followed became known as the “Deepseek Moment” — a turning point that reminded markets that no theme, however promising, can sustain parabolic price action indefinitely. Fast forward to July 2025, and we are witnessing a second leg of weakness in AI winners, with valuations compressing and momentum-driven trades unwinding at a rapid pace.
What Is a Momentum Unwind?
To understand what’s happening now, it’s critical to grasp the concept of a momentum unwind. Momentum investing — the practice of buying securities that have performed well on the expectation that trends will persist — is one of the most powerful and well-documented anomalies in financial markets. But momentum works both ways: when market sentiment shifts and trend-following investors exit en masse, prices can fall as quickly as they rose.
A momentum unwind occurs when the flow of capital that previously drove a trend reverses. This is usually triggered by one or more of the following factors:
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Crowding: When too many investors pile into the same trade, liquidity at the exit diminishes.
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Valuation extremes: As multiples expand far beyond fundamentals, even modest disappointments can cause sharp corrections.
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Catalyst shock: A negative earnings surprise, regulatory development, or product disappointment that undermines the bullish narrative.
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Macro conditions: Higher interest rates or tighter liquidity make it harder to justify high-growth valuations.
We are seeing all four factors play out in the AI space today, which suggests that the current selling pressure is more than a routine dip — it reflects a structural shakeout of crowded trades.
Why Are AI Stocks Selling Off Now?
Several catalysts have converged to trigger the latest wave of selling:
Extended Valuations
By mid-2025, many AI leaders were trading at eye-watering multiples, with price-to-sales ratios for top semiconductor names exceeding 30x and some software names commanding more than 50x forward earnings. Even bulls began to acknowledge that valuations had gotten ahead of reality. The Deepseek launch was merely the spark that exposed just how much optimism was priced in.
Competition Heats Up
Investors are also waking up to the reality that the competitive landscape in AI is evolving faster than anticipated. Chinese firms have demonstrated surprising progress, and open-source models have begun to challenge the economics of proprietary platforms, threatening pricing power for incumbents.
Shifting Macro Backdrop
Finally, the macroeconomic environment is less supportive. While interest rates have moderated somewhat, they remain elevated by post-pandemic standards, and liquidity conditions have tightened as central banks scale back balance sheets. This has reduced investor appetite for long-duration growth stories.
Historical Parallels: Lessons From the Past
The recent experience echoes similar episodes in financial history. The most obvious parallel is the dot-com bust of 2000, when overextended valuations and unrealistic growth assumptions led to a violent correction in technology shares. However, it is important to note key differences: unlike many dot-com era companies, today’s AI leaders are highly profitable, with robust cash flows and durable competitive advantages.
A more apt comparison might be the 2014–2016 biotech correction, where a similarly high-potential theme endured a prolonged drawdown before recovering and entering a more sustainable growth phase. In both cases, the longer-term technology adoption trend remained intact even as market valuations adjusted downward.
How Bad Could It Get?
While it is impossible to call a precise bottom, several metrics suggest that further downside is possible in the near term. Positioning data shows that hedge fund exposure to AI-related equities remains in the 85th percentile of historical levels, suggesting there are still crowded positions that could be unwound.
Valuations have corrected but remain elevated compared to their 10-year averages. For example, Nvidia’s forward P/E has fallen from 65x to 40x — still well above its long-term average of around 25x. Sentiment surveys also indicate that retail investor enthusiasm remains high, another sign that the shakeout may not yet be complete.
That said, corporate fundamentals remain strong, with most AI leaders continuing to report solid top-line growth and expanding margins. This creates the potential for long-term investors to accumulate shares at more attractive entry points as the dust settles.
Positioning For the Next Phase
For investors, the key is to differentiate between a structural opportunity and a speculative frenzy. Here are several strategies to consider during a momentum unwind:
Reassess Valuations
Use the current correction to identify high-quality companies with durable competitive advantages that are now trading at more reasonable multiples. Historical data shows that buying secular winners during cyclical pullbacks can generate superior returns over the long term.
Avoid the Laggards
Not all companies tied to the AI theme will survive or thrive. Avoid speculative, unprofitable names with questionable business models that were bid up purely on hype. Focus instead on firms with clear monetization strategies, strong balance sheets, and proven execution.
Diversify Exposure
AI is not a monolith — it cuts across semiconductors, cloud services, enterprise software, and even industrial automation. Diversifying across these sub-themes can help mitigate idiosyncratic risks.
Be Patient
Momentum unwinds can last longer than many expect, often overshooting to the downside before stabilizing. Investors should be prepared for continued volatility and avoid trying to time the exact bottom.
Conclusion: Key Takeaways for Investors
The recent sell-off in AI winners — the steepest since the “Deepseek Moment” — serves as a timely reminder that no trend is immune to gravity. What we are witnessing is not the end of the AI opportunity, but rather a healthy, if painful, repricing of expectations and risk premia.
Here are five key takeaways for investors:
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Momentum unwinds can be swift and brutal, but they also create opportunities for disciplined investors.
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Valuations matter, even for transformational technologies. Patience pays when waiting for reasonable entry points.
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Not all AI names are created equal — focus on quality, profitability, and sustainable competitive advantages.
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Diversify exposure and avoid over-concentration in any single company or sub-theme.
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View the pullback as part of a broader adoption curve, not as a repudiation of the long-term AI growth story.
While the path forward may remain choppy, investors who maintain a long-term perspective and apply sound valuation discipline are likely to be rewarded as the AI theme matures beyond its speculative early phase.
Disclaimer: I want to make it clear that I am not a financial advisor, and nothing I say is intended to be a recommendation to buy or sell any financial instrument. Additionally, it's important to remember that there are no guarantees or certainties in trading or investing, and you should never invest money that you can't afford to lose.
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Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.
- CrystalRose·07-08It's a tough market, but focusing on quality and a balanced approach is the key.LikeReport
- BirdieO·07-08Patience paysLikeReport