Castle Securities: The worst is over for US stocks; AI sector to lead the gains in October.

Citadel Securities strategist Scott Rubner believes that U.S. stocks are at a cyclical low and the market structure is beginning to improve. Investors should take advantage of the further pullback window before the end of the month to buy core assets on dips.

In a report to clients, Rubner stated that although the weakness of September is not yet over and the stock market may continue to be under pressure in the next two weeks, the supply and demand dynamics of the market are quietly changing. He predicts that the previously severely impacted artificial intelligence sector will be the first to stabilize and rebound in October, subsequently driving a broader market recovery.

Currently, the S&P 500 has fallen approximately 1.8% in September, down 3.2% from its mid-August high. Nine of the index's 11 sectors have recorded declines this month. Rubner points out that this pullback "is characterized by structural rotation rather than disorderly selling," a feature that lays the foundation for a subsequent rebound.

There is currently a divergence of opinion on the future of US stocks on Wall Street. Bank of America strategist Savita Subramanian recently raised her year-end target price for the S&P 500, while Ed Yardeni, considered a well-known bull on Wall Street, lowered his forecast amid accumulating risks.

There are still downside risks in September, but the opportunity to invest is approaching.

Rubner explicitly stated that the technical and supply-demand dynamics remain unfavorable for the stock market until the end of the month. "The supply-demand structure remains unfavorable at the end of the month, and technical factors continue to constrain stock prices; there is still room for further decline in US stocks over the next two weeks," he wrote in his report. "However, the situation is beginning to change."

This assessment continues the logic of his warning from about three weeks ago. At that time, Rubner, along with several market participants, warned investors to be wary of the seasonal pressure in September, historically the worst-performing month for US stocks, and suggested short-term tactical position rebalancing while maintaining a long-term optimistic stance on the stock market.

Castle Securities' backtesting analysis, based on data since 1930, shows that the S&P 500 index typically falls by about 1.1% in the last two weeks of September, followed by a recovery in October, with the rebound momentum accelerating around election day. In previous midterm election years, the S&P 500 has averaged a cumulative gain of 5.6% from its low point on September 30th to the end of the year.

The "overcapacity" in the AI sector has been digested, and tech stocks are expected to lead the market.

Rubner believes that the recent concentrated sell-off in AI concept stocks has largely digested the valuation "bubble" within the sector, creating conditions for a subsequent rebound. The Nasdaq 100 index, which is heavily weighted towards technology stocks, has fallen in five of the last seven trading days, and has cumulatively declined by nearly 6% from its early June high.

The trigger for this round of AI stock correction was a sharp rise in market concerns about the technology's potential, leading to a significant reduction in investor positions and leverage. Rubner points out that this momentum is building for a reversal.

"Three months ago, the risk was that everyone was crowding into the same trade," he wrote. "Now, the risk is that everyone is on the same side—bearish." This extreme uniformity of pessimism itself constitutes a potential reverse catalyst.

He added that technology and communications services stocks together account for about half of the total market capitalization of the S&P 500, and once the leading trend in the artificial intelligence sector is confirmed and spread during the earnings season, "the rebound is expected to far exceed the scope of the leading stocks in the first wave of the rally."

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