Investing.com -- Barclays strategist Emmanuel Cau said hot inflation data, renewed Middle East tensions and a selloff in chip stocks are testing the bank’s "narrow path higher" thesis for equities.

"Arguably, developments this week were rather unhelpful," Cau wrote in a note, noting that hot U.S. CPI and PPI prints revived concerns about further monetary tightening, renewed Middle East tensions pushed Brent crude to fresh highs, and chip stocks fell sharply. Third-quarter earnings season is also off to a mixed start, particularly for U.S. banks, which have entered correction territory.

The silver lining, Cau said, is that bond yields have finally eased, suggesting "bonds can still work as safe havens again." He said it "doesn’t make sense to worry both about the AI trade and rising yields at the same time, as they go hand in hand," and warned investors to "be careful about what they wish for."

Semiconductor and tech-heavy indices took the brunt of the selloff, with the SOX and KOSPI losing about 8% and 14% this week. Beyond the inflation surprise, Cau attributed the weakness to three factors, including intensifying competition in the global memory sector, which hit Korean stocks hardest; renewed funding and valuation concerns after two Asian data center companies delayed IPOs; and continued scrutiny over whether AI capital spending is translating into meaningful revenue.

Cau said he is less concerned about the memory competition issue, viewing the other two as not entirely new. He noted that underlying fundamentals remain intact, with strong demand guidance from both ASML (AS:ASML) and TSMC (NYSE: TSM) in their latest results, and attributed much of the recent weakness to "positioning, rather than meaningful deterioration in fundamentals", with investors "trigger-happy to take profits on any such negative headlines."

That said, Cau said the AI theme is entering "a more mature phase," with valuations, funding needs, competitive threats, regulation and revenue visibility facing greater scrutiny. "It is certainly conceivable that the best of the AI thematic trade may be behind us," he wrote, adding that investors should become "far more selective," favoring companies with proven business models, strong cash flows, visible revenue streams and reasonable valuations.

Barclays continues to advocate a more balanced sector allocation, having added to lower-beta sectors like telecoms last month at the expense of materials. Still, Cau said Big Tech fundamentals "remain generally supportive," and with much of earnings season still ahead, "it feels wise to wait before throwing the baby out with the bathwater."

He said mega-cap tech earnings will be key in the coming weeks, while continuing to view Europe as a useful diversifier given its lower exposure to AI and semiconductor concentration.

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