IS THIS THE POPPING OF THE AI BUBBLE
Since the election, the downtrend in AI stocks has accelerated.
Tech stocks and AI stocks, however, have been falling over the last six weeks.
In the chart below, you can see that the semiconductor stocks have dropped 29% since early October. My favorite tech index, the Nasdaq-100, has fallen by 15% in the last six weeks. The S&P 500 is down as well, but only 6%.
Look at the huge decline yesterday, November 5th. The semiconductor index (SMH) was down 11% in one day.
Prices have rebounded some today, the 6th, but have only recovered a fraction of yesterday’s losses.
Is this the bubble popping that everyone has been concerned about and where does the market go from here?
The trend in the semiconductor index indicates that the AI bubble popped in mid-October when it went from down -7% to down -15%. The Nasdaq-100 indicates that the bubble popped yesterday when it fell from down -9% to down -15%.
So, the AI bubble has already popped.
Is there more downside to come?
It is anyone’s guess at this point because predicting short-term moves in the stock market is not possible.
Here are my thoughts and the factors that I think will determine the answer to the “what’s next” question.
The Data Center Issue:
The AI stocks have been falling recently because of cash flow concerns among the AI hyper-scalers (Google, Amazon, Meta, Microsoft, etc.). The market is looking for payback on the massive investments that these companies have been making. This ROI concern is behind the price declines that began in early October.
With the election results this week, a new concern has been introduced to the equation. Over 75% of the American people are coming out against rapid data center expansion. They don’t want data centers in their communities, and they are very concerned about the risks of AI expanding too rapidly.
The market reacted negatively yesterday because they now think the public is going to slow down the growth of AI revenues by limiting data center expansion.
It will take some time to measure the impact that the public pushback will have on AI revenue growth. Even if new data center construction were to slow down rapidly, a lot of new capacity will still become available in the next couple of years. The balance between AI demand and AI supply in the future was unknown before the public’s pushback. For the next couple of years, with the public getting more power, it will be even harder to pin down.
As usual, the market reaction yesterday was emotion-driven and not fact-driven. With the facts unclear and a new concern on the table, investors headed for the exits.
The Valuation Issue:
Relative to their growth rates, big AI companies have been getting more attractive and not less attractive from a valuation perspective before yesterday’s bloodbath. Their stock prices have been declining while their profits have been increasing significantly.
Valuation is measured by the price to earnings ratio. The current price is the known part of the equation. The earnings part of the equation is based on future earnings expectation – the unknown part of the equation.
When prices are declining, the market is betting that these companies will not meet their earnings expectations. Yesterday’s massive decline means that the market believes that the big AI companies will miss their earnings estimates by a lot.
Recent earnings have been excellent with most companies beating their earnings estimates.
Nobody really knows what earnings will look like over the next year or two. Nvidia reports earnings on November 17th, and I expect them to post strong numbers since data center slowdowns and AI revenue slowdowns have not happened yet.
The Broader Market Impact:
The broader economy and the broader stock market have been doing well this year. The massive spending on AI in the last couple of years seeps into the rest of the economy. Revenue and profit growth have been solid in the broader market.
As of today (11/6), the equal-weight S&P 500 index is up 13.2% this year compared to the market-weight S&P 500 index which is up only 8.2%. The equal-weight index removes the outsized impact of the big tech companies.
These results say that this year’s stock performance of the non-AI companies has been better than the AI companies. Nonetheless, the equal-weight index was down -2.8% yesterday as the whole market was sold off.
Today’s job report was bullish for the overall economy with new jobs ahead of estimates.
The risk to the broader economy is the ripple effect of an AI driven slowdown.
If AI spending slows, traditional infrastructure getting the AI related contracts will see a decline in sales and profits.
The bigger risk from any AI slowdown is the impact it could have on the financial system. A massive amount of debt has been issued to cover the AI buildout. If the borrowers run into trouble paying off those loans, the impact on debt markets and the economy could be significant.
Summary:
The stock market is relying on predictions of a major slowdown in the AI expansion. AI spending and AI revenue growth have not slowed down yet.
The market could be right or it could be wrong.
If the market is correct, are your investments positioned to weather a major drop in stock prices going forward?
The last thing you want to do is to react emotionally. Any changes you come up with on your own based on fear will be bad decisions. It is too hard to get the timing right when you are reacting on the fly.
Disciplined and data-driven moves are the only ones that work.
My Growth & Safety system shines at moments like this. In fact, my system recently began moving money out of stocks and into safer assets.
The risk of stock prices declining from here are higher than the probability of a big rebound.
The beauty of my system is that it will perform well if the market goes up or goes down from here. We win if the market goes down (the higher probability right now) and the model will get us back into the market if prices go up from here.
If you are comfortable holding on through major downturns, doing nothing will work in the long term. But you could experience a lot of financial and emotional pain for several years.
If you are not comfortable with the Buy & Hold & Suffer approach to investing, we should talk soon.
We have two ways that we can help you. You can invest in my Growth & Safety mutual fund, or you can sign up for my Market Signals newsletter.
I discontinued the newsletter earlier this year, but for loyal subscribers I am making it available in this turbulent market. I don’t want my loyal readers getting badly hurt in the market.
The newsletter is a quicker solution as it can take a week to move your money into the fund.
You can get on my calendar by clicking the link below. You can start receiving my newsletter next week. Act quickly so you can protect your savings.
Stay Disciplined My Friends,
Phil
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