AI Panic Hits: Strong Capital Inflows but Deflation Concerns Trigger Rotation

Investing.com - Barclays stated in its latest report that strong macroeconomic and earnings momentum continue to support stock market demand, but concerns about AI-driven deflation are increasing and disrupting asset allocation patterns.

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In February, global stock market inflows reached $101 billion, the strongest since November 2024, thanks to resilient economic growth and improving earnings trends.

Barclays strategist Emmanuel Cau said in the report: “Although markets are becoming increasingly noisy, with AI and geopolitical narratives changing rapidly, the fundamentals of growth, policy, and earnings still support the market, and seasonal factors are also playing a role.”

They noted that buyback activity is expected to accelerate, as about 80% of buyback plans for 2026 have yet to be executed.

However, beneath the surface, allocation enthusiasm has cooled. Hedge funds and systematic investors have reduced their exposures from high levels in January, and retail investor sentiment has also become more cautious.

Barclays estimates that overall stock allocations have fallen to the 78th percentile, indicating the market is no longer overly stretched.

Meanwhile, shifts in AI narratives are driving cross-asset class movements. Strategists say investors are “shifting from enjoying the AI-building phase… to worrying about rapid AI disruption, which could lead to deflation.”

This concern has helped revive bond demand, with bonds outperforming stocks for the first time since April 2025, while inflows into high-yield (HY) credit and financial stocks have weakened.

The strategists wrote: “Worries that more companies will fall into the ‘AI losers’ camp and exit businesses are weighing on the credit market, with weak inflows into high-yield and underperformance of financial stocks.”

They continued: “We doubt these two narratives can coexist long-term. Some trade-offs are necessary, and we prefer the former over the latter, so we favor stocks over bonds.”

The bank also noted that the AI debate is driving regional and sector rotations. The latest shift from the US to other regions (Rest of World) is more driven by AI fears than monetary dynamics, with investors rotating from “new” economy sectors to “old” economy sectors.

In Europe, this has accelerated inflows into defensive and value stocks, while de-risking in tech stocks has pushed market breadth to a one-year high.

Currently, the bank expects stock volatility to remain elevated as markets digest the speed and impact of AI disruption, with rotations continuing.

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