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Introduction

Nobody enjoys hearing the captain come over the intercom mid-flight asking everyone to return to their seats and buckle up as the aircraft prepares to fly through Rough Air—especially those of us prone to motion sickness.

Markets are sending a similar message.

Momentum investors have just endured the worst momentum-factor drawdown since the Global Financial Crisis. Yes, you read that correctly—the largest momentum unwind in nearly two decades, despite the S&P 500 sitting only about 2.5% below its all-time high. That is an extraordinary level of internal dispersion and a reminder that headline index performance can mask significant deterioration beneath the surface.

The data reinforces that point. According to Cboe Global Markets, one-month implied dispersion across large-cap U.S. equities has climbed to its highest level since 2020, while implied correlation among the S&P 500's 50 largest constituents remains near record lows. In other words, stock selection is increasingly driving returns, and the gap between winners and losers has rarely been wider.

We discussed this risk last week. Periods of exceptionally low correlation often precede sharp price dislocations because correlations eventually mean revert, frequently triggered by an unforeseen catalyst. Whether that catalyst ultimately proves to be an Iran re-escalation, an inflation surprise, or something entirely unexpected is impossible to know in advance. The point is that markets appear increasingly vulnerable to an external shock.

In last week's report, we highlighted the chart below showing 1-month implied correlation overlaid with DeMark signals, noting that a DeMark 9 Buy could represent a near-term risk for equities. That signal has now activated, with the count flipping to a green 1 and 2 above the price bars. The S&P 500 has declined roughly 1.5% since the signal triggered—hardly enough to raise concern on its own. However, the previous DeMark 9 Buy in June preceded nearly a 5% pullback before buyers ultimately regained control. While no two signals are identical, the setup reinforces our view that markets may continue to encounter bouts of Rough Air before the broader uptrend resumes.

What makes this study particularly interesting is that the spread between single-stock volatility and the VIX is nearing record highs. Beneath the calm surface implied by the VIX, investors are pricing in outsized moves across individual stocks.

In other words, this is a far more treacherous market than index price alone would suggest. The S&P 500 may appear stable, but under the hood dispersion remains extreme, making this an environment where seemingly isolated events can quickly ripple through the broader market as correlations inevitably begin to mean revert.

A big reason this has flown under the radar is that the average stock is actually performing quite well. The S&P 500 Equal Weight Index (SPW) tested its all-time high on Friday before finally giving way to the late-week selling pressure.

This isn't a market-wide liquidation. It's a violent rotation beneath the surface, with crowded momentum names bearing the brunt of the selling while much of the broader market remains remarkably resilient. That is precisely what makes this environment so unusual—and why headline index performance alone tells only part of the story.

The message is echoed by the S&P 500 Advance/Decline (A/D) Line, a cumulative breadth indicator that also recorded a fresh all-time high on Thursday. Because each stock carries equal weight, the A/D Line strips away the influence of market-cap weighting and offers one of the purest measures of underlying buying and selling pressure.

Taken together, the Equal Weight Index and the A/D Line paint a much healthier picture than the recent momentum unwind would suggest. The average stock continues to participate, implying that this remains a highly selective rotation rather than the type of broad deterioration typically associated with the beginning of a bear market.

The biggest contributor to this surge in single-stock volatility has been the reversal of the AI FOMO trade. The semiconductor sector (SMH) has become the poster child for that unwind.

Prior to its June peak, the SMH had surged roughly 85%, fueled by relentless momentum buying. Since then, it has fallen nearly 20% to Friday's intraday low as investors rushed to unwind some of the market's most crowded trades.

The Goldman Sachs Momentum Basket tells an even more dramatic story, plunging as much as 36% from its June peak—the worst momentum factor drawdown in almost two decades. The takeaway is clear: this has been far less about broad market weakness and far more about an aggressive de-risking of the market's highest-flying winners.

The magnitude of the current unwind becomes even more apparent when viewed across multiple momentum factor measures. The chart below compares the Goldman Sachs High-Beta Momentum Basket, Morgan Stanley Tech Momentum Index, and the S&P 500 Momentum Index.

What makes this episode so unusual is that it is unfolding outside of a recession or a traditional bear market. Historically, momentum factor collapses of this magnitude have been associated with severe economic contractions or broad equity market declines. This time, the evidence points more toward an unwinding of exceptionally crowded positioning than a deterioration in the underlying macro backdrop.

The immediate catalyst appears to have been another "DeepSeek moment" following last week's release of Moonshot AI's Kimi K3, a next-generation open-weight large language model. Moonshot claims the model outperforms every major competitor except Anthropic's Claude Fable 5 and OpenAI's GPT-5.6 on overall capability. Meanwhile, Artificial Analysis ranked Kimi K3 ahead of Anthropic's Opus 4.8 on several frontier benchmarks, making it the first Chinese open-weight model to achieve that distinction.

Whether those performance claims ultimately prove durable is almost beside the point. The announcement was enough to reignite fears that the AI infrastructure trade had become overcrowded, prompting another wave of de-risking across many of the market's most richly valued momentum names.

The market's concern isn't necessarily that Chinese AI models are already superior. It's that they appear to be closing the capability gap while being delivered at a fraction of the cost. That raises an uncomfortable question for investors: if frontier AI becomes increasingly commoditized, are today's premium valuations for the AI supply chain still justified?

Whether those fears are justified is not our call—we'll leave that to the AI experts. Our job is to understand how markets respond. In crowded trades, perception often matters more than reality in the short term, and investors rarely wait for all the facts before reducing risk. That is a large part of why the semiconductor sector (SMH) has fallen roughly 20% in such a compressed time frame.

Stay tuned.

Earnings season now becomes the next major catalyst. The market's AI leaders will be under the microscope as investors look for tangible evidence that hundreds of billions of dollars in AI infrastructure spending are generating attractive returns. Technology was the weakest-performing sector both last week and throughout July. Whether management teams can restore confidence—or whether investors continue to demand proof over promises—will likely determine whether this momentum unwind has further to run or is nearing exhaustion.

With anxiety running high and the major indexes beginning to show signs of stress, earnings season has the potential to make—or break—the market's near-term direction.

Now let's see what the charts have to say.