Castle Securities strategist Scott Rubner believes that the AI sector selloff has already priced in a valuation bubble; meanwhile, the prevailing bearish sentiment could serve as a reversal catalyst. Based on historical data from backtests, during mid-term election years the average S&P 500 gain from late September to year-end is 5.6%. He also noted that technical conditions and supply-demand dynamics remain unfavorable for the stock market before the end of the month, and that U.S. stocks still have further downside potential over the next two weeks.

Castle Securities strategist Scott Rubner believes that the U.S. stock market is at a temporary low point, and that the market structure is beginning to improve. Investors should take advantage of the additional pullback window before the end of the month and add to core assets on dips.

Rubner said in a client report that although the weakness in September has not yet ended, the stock market could remain under pressure over the next two weeks. However, the market’s supply-demand dynamics are quietly starting to shift. He expects the artificial intelligence segment—previously hit hard—to stabilize and rebound first in October, and then to pull the broader market along.

So far, the S&P 500 has fallen about 1.8% in September, down 3.2% from the mid-August peak. Of the index’s 11 sectors, 9 are recording declines this month. Rubner said the current pullback "looks like a structural rotation rather than a disorderly selloff," a feature that sets the stage for a subsequent rebound.

Wall Street’s outlook on the future of U.S. stocks remains divided. U.S. Bank strategist Savita Subramanian recently raised her year-end target for the S&P 500, while Ed Yardeni—seen as a well-known bull on Wall Street—cut his forecast amid an environment where risks are accumulating.

Still downside risk in September, but the time to position is approaching

Rubner said plainly that the technical picture and supply-demand setup remain unfavorable for the stock market before the end of the month. "The end-of-month supply-demand structure remains unfavorable, and the technical picture is still constraining stock prices. There is still downside room for U.S. stocks over the next two weeks." He wrote in the report, "But the picture is beginning to change."

This assessment follows the warning logic he delivered about three weeks earlier. At that time, Rubner, together with several market participants, issued alerts to remind investors to guard against the seasonal pressures associated with September—the worst month for U.S. stocks in history—and advised resetting positioning tactically in the short term while maintaining a long-term optimistic stance toward the stock market.

Castle Securities’ backtests based on data since 1930 show that the S&P 500 averages a drop of about 1.1% in the last two weeks of September, then begins to recover in October, with rebound momentum continuing to accelerate around the time of the election. In each midterm election year, from the Sept. 30 low to year-end, the S&P 500’s average cumulative gain is 5.6%.

"AI sector" overcapacity has been digested, and tech stocks could lead the rally

Rubner believes that the recent concentrated selloff in AI-related stocks has largely priced in the "valuation bubble" within the sector, creating conditions for a follow-on rebound. The Nasdaq 100, led by technology stocks, has declined on 5 of the past 7 trading days and is down nearly 6% from the early-June peak.

The trigger for this AI stock pullback is that investor concerns about the technology’s potential capabilities have surged sharply, leading to a clear contraction in investors’ positioning and leverage. Rubner pointed out that this momentum is building energy for a reversal.

"Three months ago, the risk was that everyone piled into the same trade," he wrote, "and now, the risk is that everyone has already taken the same side—bearish." This extreme, one-minded pessimistic outlook itself constitutes a potential contrarian catalyst.

He added that tech and communication services stocks together account for roughly half of the S&P 500’s total market value. Once the AI leadership trend is confirmed during earnings season and spreads, "the rebound’s upside could be expected to exceed the category of leaders in the first wave of stocks."