By Jennifer Sor

Jul 24, 2023, 11:03 AM EDT

The red-hot rally in stocks is mostly being driven by FOMO, and the excitement for AI won't be enough to stop most artificial intelligence stocks from bottoming, according to Main Street Research chief investment officer James Demmert.

In a note on Monday, he pointed to unusually low volatility in the market as a sign that investors are trying to chase the momentum in stocks. In fact, the stock market's volatility gauge is now hovering near a record-low, indicating that heightened bullishness from investors is running the show.

"The recent market strength is being driven by FOMO (Fear of Missing Out) by both retail and institutional investors," he said. "We do not think the daily grind upward in the stock indexes is sustainable, largely amid the possibility of mixed earnings reports over the next few weeks and the possibility of yet another Fed rate hike. Rather than chase stocks at these levels, investors would be wise to be patient at this point and use any corrections as a buying opportunity."

Equities could face resistance as soon as Wednesday, when investors expect the Fed to raise interest rates another 25 basis points to continue taming inflation. That would lift the fed funds rate target to 5.25%-5.5%, the highest since 2001.

The Fed is also likely to issue hawkish guidance at the end of its policy meeting, Demmert added, which could also be a negative for stocks. That's because central bankers are looking to contain investor excitement over the market, which works against the Fed's goal of tightening financial conditions.

Meanwhile, tech giants Alphabet, Meta, and Microsoft are set to report their quarterly earnings this week. That could result in more weakness for the AI sector, since tech firms that have reported so far have issued "cautious" forward guidance, Demmert said.

"We tell investors who have a case of FOMO that only a small part of the train has left the station, as most stocks are still bottoming. The AI-related stocks that have left the station are likely to back up allowing for a better entry level," he warned.

Other commentators have warned Wall Street's excitement for AI could soon falter as the enthusiasm for artificial intelligence overheats. Tech shares suffered a $2 billion outflow in mid-June – a sign that a small bubble in artificial intelligence could already be starting to deflate, Bank of America suggested.

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