Castle Securities strategist Scott Rubner believes that the AI sector selloff has already priced in the valuation bubble; the prevailing bearish sentiment now serves as a reversal catalyst. Based on historical backtesting, during mid-term election years, the average S&P 500 gain from the end of September through year-end is 5.6%. He also noted that, before the end of the month, technical conditions and supply-demand dynamics remain unfavorable for the stock market, and that the U.S. stock market still has room to move lower 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 starting to improve. Investors should take advantage of the window for further pullbacks before the month’s end and add to core assets on dips.

Rubner said in a client report that although September weakness has not yet ended, the stock market could continue to face pressure for the next two weeks. However, the market’s supply-demand dynamics are quietly changing. He expects that the previously hard-hit AI sector will stabilize and rebound first in October, and then prompt a broader market to follow.

Currently, the S&P 500 index has fallen about 1.8% in September on a cumulative basis, down 3.2% from the mid-August peak. Of the index’s 11 sectors, 9 recorded losses this month. Rubner said that this pullback "has looked like a structural rotation rather than a disorderly selloff," a feature that lays the groundwork for a rebound later on.

There is disagreement on Wall Street about the outlook for US stocks. Savita Subramanian, a strategist at Bank of America, 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 risk build-up.

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

Rubner said clearly that by the end of the month, the technical picture and supply-demand dynamics will still be unfavorable for the stock market. "The supply-demand structure at month-end remains unfavorable, and the technical picture is still restraining the stock price. There is still room for downside in US stocks over the next two weeks," he wrote in the report. "But the situation is starting to shift."

This assessment follows the warning logic he issued about three weeks earlier. At that time, Rubner and several market participants jointly cautioned investors to guard against the seasonal pressure of September—the historically worst month for US equities—and suggested resetting tactical positioning in the short term while maintaining a long-term optimistic stance toward the stock market.

Castle Securities’ backtesting analysis based on data since 1930 shows that the S&P 500 index has averaged a drop of about 1.1% in the last two weeks of September, followed by a recovery in October, with rebound momentum continuing to accelerate around and before the election. In the midterm election years, from the Sept. 30 low to year-end, the S&P 500 has averaged a cumulative gain of 5.6%.

The AI sector’s "excess" has been digested; tech stocks are poised to lead the rally

Rubner believes that the recent concentrated selloff in AI-related stocks has largely priced in the sector’s "valuation bubble," creating conditions for the subsequent rebound. Over the past nearly seven trading sessions, the Nasdaq 100 index, centered on technology stocks, has fallen on five days and is down nearly 6% from its early-June peak.

The spark for this AI-stock pullback is that investors’ worries about the technology’s potential capabilities have surged sharply, causing their positioning and leverage levels to be noticeably compressed. Rubner noted that this momentum is building energy for a reversal.

"Three months ago, the risk was that everyone crowded into the same trade," he wrote, "and now, the risk is that everyone has taken the same side—bearish." This extreme, synchronized pessimism itself constitutes a potential contrarian catalyst.

He added that technology and communications-services stocks together account for about half of the total market value of the S&P 500. Once the AI leaders’ surge in the sector is confirmed in the earnings season and spreads, "the rebound magnitude could be expected to exceed the scope of the first-wave leading stocks."