For those of you who would prefer to listen:
The consequential Midterm election has come and gone. The results seemingly registered on the Richter Scale. On the eve, it appeared quite evident that the Democrats were going to have a good night. But I suppose even the most optimistic Democrats didn’t anticipate this outcome. The results were crystal clear. As one of our Washington sources put it: “This was a wipeout of historical proportion.” It was absolutely Market-moving.
The Market’s initial reaction was lower. The overnight Futures had the S&P 500 down nearly 2%. It didn’t last. Wednesday morning brought an explosive rally, with the Dow leading the charge, surging 1,500 points. It was the best day of the year for stocks. Then came Thursday. All of those gains, and then some, were erased. Tech definitely got it worst. The AI trade officially broke. There had been cracks for weeks. But the aftermath of the midterm election saw the bubble finally burst.
A whopping $2.5 Trillion was taken out from the Tech-heavy Nasdaq. It was the worst intraday drop since the height of the COVID-19 pandemic in March 2020. It was its largest point decline ever. Importantly, the NAS had already trailed the Dow and S&P the prior day. Honestly, Wednesday was a curious move higher. Wall Street is expected to experience much more oversight now with the Democrat-controlled Congress. The Market doesn’t usually like that. The Democrats have much bigger numbers than expected. That helps explain some of Thursday’s decline. But there’s much more. AI was on the ballot too. The massive data center build is flashing yellow and, in some states, red.
The Market reaction was telling. The Tech Titans, led by Amazon, Microsoft and Google, saw their stocks rally Wednesday while the AI infrastructure stocks sold off. The thinking on this was, the Tech Titans already corrected in response to earnings reports and were primed for a bounce. In addition, Amazon, Microsoft and Google are the entrenched companies in existing data centers who are providing the computing power for AI. These are the companies that have the servers and the market share and are extremely well capitalized to continue. Plus, a reduced AI buildout would result in a return to free cash flow positivity for the Tech Titans. The Market likes those prospects.
The newer AI players are dependent on the new data center builds which created the opportunities for growth. If they stall or get stopped, that’s bad for those companies. Thursday’s sell-off was bad for nearly all companies. Expect a lot more scrutiny on AI with this new Congress. It’s already started. Bottom line: It’s going to cost more and take longer. That will most certainly slow revenues and earnings, which the Market is no doubt now grappling with.
The AI boom had already entered the more challenging stage. The aggressive spending had been coming from cash flow. Then it turned to debt. That made for a tricky path forward when inflation and higher interest rates rule the day. Tightening credit conditions, rising infrastructure costs, and tougher regulation threaten weaker projects. Speculation faces gravity. That is generally bad for smaller companies and those dependent on debt to grow. The Market has finally started paying attention to risk. Capital is likely to concentrate among large companies with stronger balance sheets and more predictable revenue streams. That’s what’s happening now.
Friday brought a bit of a reprieve. It scratched a little bit back. The Dow was red. The stuff that got beat up the most generally won the day. They definitely lost the week. There was a lot of damage done. It was fast and furious. We had been expecting a pick-up in volatility, though admittedly we didn’t anticipate anything like what Wednesday and Thursday brought. Oversold bounces are likely as we head towards year-end. But it seems to us that the Market still has some unfinished business. We do see more corrective price action ahead. And the set-up for 2027 now looks even more tricky.
Asset bubbles aren’t exactly rare, though they don’t occur all that often. But when they have, it’s been quite impactful for investors. Over the Summer, I wrote about the expanding AI bubble with context to others throughout history. It was titled “How Bubbles Burst”. I re-circulated it to the team this morning for reference. I thought it might be useful for you too to re-visit it, should you choose.
To read the full article, click here.
Have a nice weekend. We’ll be back, dark and early on Monday. Our offices will be closed on Wednesday, in honor of our nation’s veterans. The Bond Market will be closed, but the Stock Market will be open. Rest assured, members of our team will be at the ready to transact, should it be necessary.
Mike
