Don't look now fans but there is a new "fear trade" in town. You remember how these work, right? To review, a fear trade starts with traders shouting their negative narratives from the rooftops while shorting stocks at the same time. "The sky is falling!" they proclaim. "The market has it all wrong," they contend (I'm looking at you Mr. Big Short). "Trust us, we know how this will end," they say. And "Get out now, before you lose all your money," they cry.

Next, emotion starts to set in. As prices move down in a violent, disturbing fashion (driven by undiscerning computers, of course), investors lose their resolve and forget why they bought the positions in their portfolios now creating all the anxiety. Worry becomes the theme of the day, every day. Selling begets more selling because (a) the trade becomes a trend covered in the media and (b) the outlook seems to become more dour by the day. So little time, so much to fear!

As an investor who's watched this type of trade play out a time or two in my career, I can say the great thing about a fear/scare trade (assuming you are the one making the trade) is you don't really need any metrics - or even any facts on which to base your thesis. Nope, you just need to find/create a good narrative, have a great deal of capital, lots and lots of conviction, and then continue repeating your view over and over again until the panic that turns your trade into gold sets in.

To be sure, we've seen this movie before. Many, many times. The theme changes with the times (the Fed will make a mistake, tariffs will kill the economy, inflation will soar, a recession is coming, oil is going to $0 (or $200), WW III is about to begin, etc.) but the trade does not.

This time around it's a little something called the "AI Fear Trade." And while the major indices have been holding up pretty darn well lately, there has been some serious pain in certain segments of the market. You know, the areas that we're told we need to be so very fearful of. As in, anything that can be disrupted by AI.

The Fear Narrative

The narrative for the current fear-of-what-might/could/maybe-happen trade goes something like this: AI is going to destroy the business models of companies in the software, legal, real estate, wealth management, tax advice, and even trucking/logistics industries. Yep, that's right, these industries are doomed by the efficiencies created by AI (which, of course, may or may not itself be in a massive bubble - I'm not exactly sure how both of these arguments can exist at the same time, but no worries, just keep selling!).

As such, our furry friends in the bear camp tell us that a meaningful correction to the multiples at which these companies trade (aka a "reset") is necessary - and fast! (Why else would a trucking company's stock fall -24% in one day without any news?)

The Heck With Fundamentals

Never mind the fact that the current earnings (as well as future guidance) for the companies in these industries show no signs of any distress. Nor do the analysts and executives of these companies expect any difficulty in the future. For example, according to Bloomberg, "There's little fundamental evidence of deterioration" in these companies. For example, "earnings for software and services companies in the S&P 500 [are] projected to rise +19% in 2026".

The chart below tells the story here as the orange line is the consensus earnings growth estimate for the software industry in 2026. Lest we forget, usually a line on this type of chart moving from the lower left to the upper right is viewed as a good thing.

So, while software companies (using iShares Software EFT IGV as a proxy) have fallen more than 30% (-31.9% to be exact) since the beginning of November, the earnings estimates from Wall Street analysts (you know, the ones who aren't short the stocks they are covering) have actually been going UP!

But... The guys and gals running Wall Street trading desks and the big hedge funds tell us that the analysts and the folks running these companies are all wrong. These companies are all going to experience a massive disruption - and soon. They don't know it and they don't see it, but just wait, the sky will surely fall in on them all.

The trading masters of the universe that can apparently predict the future perfectly have been shorting these stocks - in a big way. For example, as I reported last week, according to Goldman's Prime Brokerage Unit, last week's short selling was the largest on record.

So, it is important to understand that not just anyone can get a good fear/scare trade going. No, one of the requirements to a successful fear/scare trade is you have to make your trades in size. As in, massive size - so that the unrelenting selling makes it look like something really bad is actually happening.

The key "tell" that lets you know that a fear/scare trade is happening is that the big dives and the huge increase in volatility occur with no news whatsoever. The stocks being slammed this time around have generally reported strong earnings and provided upbeat guidance. But that doesn't matter to the fear-mongering short sellers. No, just keep selling and repeating your narrative. Party on, Wayne!

We've Seen This Movie Before

As I opined above, this type of scare/fear trade is a well-worn page in the Wall Street trading playbook. In fact, we experienced the joys of such a trade less than a year ago - in the spring of 2025. You remember, right? That time it was the known as the "Tariff Tantrum," where traders were absolutely, positively sure that tariffs would wreak havoc on the economy and earnings and create a resurgence in inflation. It couldn't be stopped. A disaster was going to happen, for sure.

As fear caught on, the selling intensified, eventually taking the S&P 500 down -21.3% in 2 short months. All based on, yep, you guessed it, the fear of what could/might/maybe happen. And all thanks to your friendly neighborhood hedge fund and Wall Street trading desks. Well done boys.

However, a funny thing happened on the way to the tariff disaster. The same thing that usually transpires after this type of fear/scare trade. It... just... didn't... happen.

All that fear turned out to be unwarranted. You see, those so-called experts making all the dire predictions turned out to be wrong. As in dead wrong. Instead of the economy tanking and inflation surging, US GDP has been growing nicely at an above-trend clip and inflation has moved only a smidge higher (something that is completely normal when the economy is doing well) since the last fear-based freakout began.

The funny/annoying thing about all of this is these traders don't have to be right to make money. No, they just have to make the trade work. And work it did as Wall Street Banks reported record profits from their trading desks in the 2nd quarter of 2025. Oh, and for those of you keeping score at home, trading desks broke that record in the fourth quarter last year. Hmmm, I wonder if all that negativity about AI had anything to do with that...

At What Price Value?

To be sure, watching stocks get hammered by traders is no fun. However, the silver lining is that the scare/fear trade is starting to create serious values in some pretty big names. For example, according to eSignal, Microsoft (MSFT) is currently trading at a PE ratio of 25.01. For perspective, the low end of its 5-year PE range is 23.6. The high end is 40.3. And the average is 33.1.

In fact, the entire software sector is suddenly looking cheap. Check out this chart...

And for the record, the software sector is now EXTREMELY oversold thanks to the relentless selling. According to Ned Davis Research, the 63-day rate of change is currently lower than all but one other point in history. It turns out the oversold condition was slightly lower in early 2000. Talk about historical perspective!

What To Do?

The message from my $0.02 opinion on what is happening in the market these days is that there are times when the market's "message" may be more a reflection of the opinions of fast-money traders seeking profits than the market at large. History has taught us that, generally speaking, Wall Street tends to overdo almost all big moves - in both directions. And from my seat, this feels like one of those times.

So, unless you make your living trading, this is probably time to be looking at doing some buying. I'll be looking for those companies that have been caught up in the baskets of short trades where reality doesn't fit the narrative being promoted.

For example, should we really believe that Microsoft (MSFT) ought to be cheaper today than it was 5 years ago? And should we believe that all software companies are the same here? I know of at least a couple firms that USE AI for the benefit of their customers. And I'm not sure why they've been lumped into the selling basket. But who am I to judge, right?

So, as I insert a head-shaking emoji here, I will be looking for such disconnects and making some investments. Not "trades" mind you. No, these would be investments I plan to hold for a longer-term time frame - not lunch on Thursday!

Thought for the Day:

It is better to look ahead and prepare than to look back and regret. -Jackie Joyner-Kersee

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: MSFT - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES