Chip weakness may signal fading AI profitability as defensive stocks rise

Weakness in semiconductor shares alongside gains in defensive sectors may be an early warning that expectations for AI profitability and broader market risk appetite are cooling.

The simultaneous rotation out of chip stocks and into defensive shares warrants a fresh look at the earnings outlook for companies that have led the AI investment boom and at investors’ willingness to take risk.

In an Oct. 14 interview with David Lin, Cameron Dawson, chief investment officer at NewEdge Wealth, said price action in the KOSPI and semiconductor shares could foreshadow changes before they appear in earnings forecasts. “Price leads data,” she said.

Dawson said the KOSPI was oversold, along with parts of the U.S. semiconductor sector and Chinese technology shares, leaving room for a short-term rebound. However, a strong uptrend should quickly recover its previous high, while a weaker trend that moves sideways and breaks support may indicate that stocks are forming a top.

Earnings estimates for semiconductor companies are still rising, but Dawson said expectations for 2027 are demanding. EBIT margins for the semiconductor index jumped from 16% in 2025 to 42% in 2026, and estimates call for them to reach 49% in 2027. She said the price weakness raises questions about whether those forecasts are reasonable.

Dawson attributed the surge in profitability to AI capital spending by large technology companies and semiconductor makers’ strong operating leverage. Companies making the investments can depreciate capital expenditure over an extended period, while suppliers recognize the related revenue immediately. “One man’s capex is another man’s revenue,” she said, adding that higher prices and volumes can turn modest revenue gains into much larger profits.

The S&P 500’s margins have also become heavily dependent on semiconductors. Dawson said the index added 5 percentage points to EBIT margins in 2026, while Wall Street expects another 2 percentage points of expansion in 2027, driven by semiconductor margins. A slowdown in chip demand could therefore pressure index-level margins even if average corporate earnings remain healthy.

Deteriorating market breadth is another warning sign. Almost 40% of S&P 500 stocks are down 20% from their all-time highs, while the index itself remains about 2% below its record. Dawson described it as a stark market of haves and have-nots, adding that renewed weakness in bank stocks after earnings reports showed how difficult it has been to sustain a rebound.

Meanwhile, leadership from utilities and consumer staples points to weaker risk appetite. Dawson did not interpret the rotation as an immediate signal of sharply weaker growth or a deep bear market, but said investors should not celebrate when those sectors lead because it suggests growing caution around the economic outlook.