What's Happening to the AI Rally? Billionaire Investor Stanley Druckenmiller Just Exited Nvidia and Is Now Piling Into Bank Stocks.

Artificial intelligence (AI) stocks have been all the rage this year, climbing the charts in hockey-stick-like fashion and reaching meteoric valuations. Some expect the rally to continue as interest rates decline and the Federal Reserve engineers a soft landing for the U.S. economy, in which inflation falls and a major recession is avoided.

Others, however, are concerned that scenario won't happen and that the AI market has gotten too frothy. One of these investors appears to be the billionaire hedge fund manager Stanley Druckenmiller, who now invests through his Duquesne Family Office. Duquesne recently filed its 13F filing with the Securities and Exchange Commission (SEC), detailing Druckenmiller's holdings at the end of the third quarter.

Here's what it shows. The George Soros protege exited his position in the chipmaker Nvidia (NASDAQ: NVDA) and is now piling into bank stocks. Let's see what might be the reasons.

Nvidia is trading rich for Druckenmiller

It's no secret that Druckenmiller has soured on Nvidia. Duquesne in the second quarter of the year cut its stake by 83%. Druckenmiller is undoubtedly a bull on artificial intelligence and believes in its potential. But he grew concerned about the valuation: "What changed is it tripled in a year, and I thought the valuation was rich," he said in an interview with Bloomberg. Still, Druckenmiller said he made a mistake in selling Nvidia too early and would consider buying the stock again on weakness.

NVDA PE Ratio (Forward) data by YCharts

It's tough to sell businesses you truly believe in, but valuation is important. Bad companies can sometimes trade at attractive valuations worthy of potential investment, while great businesses can do the opposite.

Piling into boring old banks

Banks are not the most exciting investments. I personally find them interesting and invest in them, but I understand why companies like Nvidia are more attractive. Banks operate many seemingly commoditized businesses and there is a lot of competition with over 4,500 banks in the country. But again, any stock can become interesting at the right price -- and that's what happened to banks.

Investors left the sector for dead after a banking crisis in early 2023, a tough regulatory regime, an inverted yield curve, and the threat of much higher regulatory capital requirements. However, with interest rate cuts, a steepening yield curve, and a friendlier incoming Trump administration, bank stocks have soared and have been one of the biggest beneficiaries since Election Day.

Druckenmiller read the tea leaves and loaded up in the third quarter, taking the following names:

• SPDR S&P Regional Banking ETF (NYSEMKT: KRE)

• Citigroup (NYSE: C)

• M&T Bank (NYSE: MTB)

• Truist Financial Corp (NYSE: TFC)

• U.S. Bancorp (NYSE: USB)

• Huntington Bancshares (NASDAQ: HBAN)

• Citizens Financial Group (NYSE: CFG)

• KeyCorp (NYSE: KEY)

• First Horizon Corp (NYSE: FHN)

• Ameris Bancorp (NYSE: ABCB)

• First Citizens BancShares (NASDAQ: FCNCA)

Druckenmiller previously had some bank stocks in his portfolio, but many of his holdings were foreign banks. Now, he's flashing green on the U.S. bank sector. He could have bought the regional banking ETF and called it a day. Instead, he bought most of the super-regional banks. Druckenmiller likely sees growing profits in the new environment. He may also be anticipating the return of bank mergers and acquisitions. With a lighter regulatory regime, some super-regional banks may merge or get bought as the players in this space angle to get bigger and add scale.

He has also expressed concern about fiscal recklessness driving up long-term bond yields. This could benefit banks through a widening yield curve. The yield curve maps Treasury bonds of different durations and the yields they pay. A steepening curve occurs when longer-dated Treasuries pay higher yields than shorter-dated bonds. This benefits bank margins because banks typically borrow short and lend long, so Druckenmiller may view banks in some way as a hedge if the country's debt situation gets out of hand and buyers of Treasury bonds demand more yield for the risk.

Is the AI rally nearing an end?

Not necessarily. Duquesne opened a new stake in Taiwan Semiconductor Manufacturing (NYSE: TSM) in the third quarter. But I think Druckenmiller is signaling overbought conditions, and that he would rather wait for dips to buy. Other billionaires like Warren Buffett appear to be articulating the same.

Of course, even the best investors get it wrong and retail investors should never follow anyone blindly because everyone has a different mindset, goals, and risk tolerance when investing. However, retail investors should understand that valuations are high and could sell off. If you plan to hold a stock for the next 10 or 20 years, then you don't necessarily need to change your strategy, but don't be surprised if there is a correction at some point.