The AI rally is not over, but short-term summer correction pressure remains

Overview

This report discusses the pullback in the Japanese AI market since late June 2026. The core judgment is that the medium-term AI rally has not ended, but in the short term it will face pressure from worsening foreign fund flows, summer position adjustments, and momentum reversal. The report suggests investors do not need to fully exit medium-term positions related to AI and semiconductors, but can tactically allocate to domestic demand value stocks during the summer period.

Core views

First, the recent pullback is more the combined result of a retreat after a strong rise, foreign profit-taking, and seasonal fund flows, rather than the end of the fundamental AI theme. Second, foreign investors made substantial net purchases of Japanese equities in 1H 2026, making the market impact of subsequent rebalancing potentially more pronounced. Third, foreign investors have high exposure to AI, semiconductors, momentum, growth, large-cap, and high-volatility stocks, so if rebalancing continues, related factors may come under pressure. Fourth, domestic demand value stocks have still shown relative resilience in 2026, and their shorter-duration characteristics may benefit from rising Japanese interest rates.

Analysis framework

The report combines seasonality in monthly and weekly foreign cash equity flows, historical monthly TOPIX returns, monthly returns of major factors, cumulative factor performance since 2026, an analogy to the SOX index during the internet bubble period, and the performance of value factors within the domestic demand stock universe to form its strategic judgment.

Methodology notes

• Fund flow and seasonality analysisSeasonality of foreign cash equity flows

  Foreign investors usually net sell from August to September and turn to net buying in October

  The report uses historical foreign cash equity trading data to show that the Japanese market often experiences foreign outflows and index weakness in summer, which forms an important basis for its judgment of this short-term correction.

• Quantitative factor analysisStyle factor exposure and reversal

  Momentum, growth, large-cap, and high-volatility factors may reverse along with foreign rebalancing

  The report believes foreign investors currently have high exposure to AI and semiconductor-related stocks as well as momentum, growth, large-cap, and high-volatility factors, so foreign position adjustments will amplify short-term pullbacks in these factors.

• Historical analogyAnalogy to SOX performance during the internet bubble period

  Even during long-term thematic rallies, quarterly pauses may occur

  The report notes that from July to September 1999, the SOX index paused during a larger bubble upswing, using this to illustrate that the medium-term AI rally may not end because of a short-term correction.

• Stock screeningDomestic demand value stock screening

  At least 90% domestic sales, excluding financials, bottom 20% by P/B, with OW or EW ratings

  The report uses this screening framework to identify Japanese domestic demand value stocks that may relatively benefit during a period of weak summer fund flows and rising interest rates.

Asset mapping & comparison

Structured mapping from thesis to named assets (strengths, weaknesses, peers, risks).

• Japanese AI and semiconductor-related stocks

  The main medium-term thematic line, but under short-term correction pressure

  Strengths

  The report does not negate the medium-term AI rally, and recovery remains possible after the correction.

  Weaknesses

  Foreign positioning is crowded and momentum gains have been large, making them vulnerable in the short term to profit-taking and seasonal outflows.

  Comparison

  Compared with domestic demand value stocks, AI and semiconductor-related stocks are more affected in the short term by foreign flows and high-volatility style exposure.

  Risks

  If foreign outflows exceed expectations or momentum reversal broadens, the short-term pullback could be deeper than expected.

• Japanese domestic demand value stocks

  Tactically preferred assets during the summer period

  Strengths

  Their domestic-demand characteristics reduce sensitivity to external demand and foreign risk appetite, the value factor remains effective within the domestic demand stock universe, and their shorter-duration characteristics relatively benefit from rising interest rates.

  Weaknesses

  If the AI growth style recovers quickly, domestic demand value stocks may relatively underperform high-growth sectors.

  Comparison

  Compared with AI and semiconductor-related stocks, domestic demand value stocks are more defensive and interest-rate sensitive.

  Risks

  If Japanese interest rates decline or domestic demand fundamentals weaken, support for value stocks may diminish.

• Momentum, growth, large-cap, and high-volatility factors

  The main risk exposures of foreign rebalancing

  Strengths

  They had previously accumulated strong performance along with the AI and semiconductor rally.

  Weaknesses

  Foreign exposure is high, so once funds withdraw, reversals can easily occur.

  Comparison

  Relative to value and domestic demand factors, these factors are more vulnerable to profit-taking during the summer.

  Risks

  Factor reversal may spread to broader Japanese equity indices.

• Revision factor

  The report maintains a constructive medium-term view

  Strengths

  From a factor perspective, the report remains medium-term positive on Revision.

  Weaknesses

  In the short term, it may still be dragged down by the overall market correction and declining risk appetite.

  Comparison

  Compared with pure momentum factors, Revision is more tied to fundamental expectation revisions.

  Risks

  If earnings revisions weaken, factor support will decline.

Key data

• Report date2026-07-13The report was published on July 13, 2026 03:25 AM GMT.
• Foreign net buying of Japanese cash equities in 1H 2026About ¥10trnThe report believes such strong prior buying makes it unlikely that the subsequent pullback will be small.
• Seasonality of foreign flowsUsually net selling in August and September, usually net buying in OctoberThis is a key basis for the report's view that summer correction pressure may persist.
• Potential duration of pressureAbout 6 weeksIn weekly data, historical outflows are usually concentrated from late August to the end of September.
• Expected timing for AI rally recoveryAround early SeptemberThe report believes foreign position adjustments seem to be occurring earlier than usual seasonality this year, so the recovery timing may also come earlier.
• Definition of the domestic demand stock universeAt least 90% domestic sales, excluding financial stocksUsed to observe cumulative returns of various factors within domestic demand stocks.
• Screening criteria for value domestic demand stocksBottom 20% by P/B, and rated OW or EW by Morgan Stanley ResearchThe report lists such stocks as potential tactical beneficiaries.
• Rating time frame12 to 18 monthsMorgan Stanley equity ratings are typically risk-adjusted comparisons versus the average total return of the industry coverage universe.

Impact & implications

For investors, the report's message is not to exit the AI theme, but to manage summer pullback and crowded-trade risks. In the short term, investors should watch foreign outflows, momentum reversal, and adjustments in high-volatility growth stocks; in the medium term, they can still retain AI- and semiconductor-related allocations while using domestic demand value stocks as a tactical supplement for defense and a rising-rate environment.

Risks

• Seasonal foreign outflows from August to September may exceed historical averages.
• The large scale of foreign net buying in 1H 2026 may intensify pullbacks in AI and semiconductor-related stocks through profit-taking.
• Momentum, growth, large-cap, and high-volatility factors may experience chain reversals.
• The report's timing for the recovery of the AI rally depends on the assumption that foreign rebalancing occurs earlier than usual.
• The SOX pattern during the internet bubble can only serve as a reference and cannot be mechanically applied to the current AI market.
• If interest rate trends move contrary to expectations, the relative advantage of domestic demand value stocks may weaken.

What to watch

• Net buying/selling direction of foreign cash equities and the intensity of weekly outflows from August to September.
• Whether AI and semiconductor-related stocks stabilize relative to TOPIX.
• Whether cumulative returns of momentum, growth, large-cap, and high-volatility factors continue to reverse.
• Changes in Japan's 10-year government bond yield and their impact on value stocks.
• Whether the AI theme sees returning fund flows and a recovery in relative strength around early September.
• Performance of stocks with high domestic sales exposure, lower P/B, and OW or EW ratings.