"Markets bottom on bad news," is one of those smart-sounding rules of thumb that proves true just often enough to remain a Wall Street cliché in good standing.
Did the brutal weeks-long punishment of AI stocks culminate last week and reverse higher Monday after a pileup of adverse headlines? In the past week, American voters resoundingly opposed data-center construction across much of the country and Anthropic lowered its target IPO valuation just before a sex-and-espionage scandal struck the one-man embodiment of the entire AI economy, Nvidia's Jensen Huang.
The story of a market taking a cue from a crescendo of bad news after a nasty setback to stage a resounding bounce holds together well enough for now, after Monday's 3.4% jump in the Nasdaq-100 and 7% rip in the Philadelphia Semiconductor Index (SOX), even as Nvidia shed 4.3%.
Based purely on the tactical evidence, the tech-hardware complex came into the week pretty well washed out and primed to bounce. Numerous trading desks reported historically rare intensity of net selling in the group by institutions into last Thursday's risk purge. The Nasdaq-100 was as oversold on several metrics as it had been at the March 30 Iran-selloff low. The CBOE S&P 500 Volatility Index has put in a nice spike of the sort usually associated with a passing storm, shooting up to 28 and then receding below 20.
The recent dump in the Nasdaq and uptick in risk aversion, "had many elements of capitulation," says Laurent Laskowski, options strategist at Baird Strategas: "record options activity, a sharp spike in volatility, skew and correlations, an inverted VIX curve, and forced liquidations…The setup, therefore, is one where the market is seeing the [downside] left tail narrowing while the [upside] right tail is fattening."
Several technical-analysis gurus (including Macro Risk Advisors' John Kolovos, whose work is cited below) argue the market hasn't quite served up a "fat pitch" to buy the pullback aggressively. Maybe so. But FanGraphs calculates that in Major League Baseball only about 7% of all pitches are in the very center of the strike zone. While those fat pitches result in some 23% of all home runs hit, the other three-quarters of balls that fly over the wall come with less-perfect setups around the edges of the zone.
I wouldn't argue too strenuously against this tech-centered rally carrying on for a bit, for these reasons as well as the fact that valuations have become far less demanding. Last week, I noted Big Tech had not to that point responded to moderately stressed conditions but was getting closer, and "the bull market built on the AI story will almost surely need the AI story to get back on track to keep advancing. A prolonged period when the equal-weight S&P 500 outperforms the market-cap-weighted version is otherwise known – usually – as a bear market." Monday's blip higher could be a start, with plenty still to prove.
But this AI-driven part of the market has lately shown itself less worthy of investor trust, leaving enough hints of structural damage to the bull case that faith can't be restored right away.
In a late-June column, I asked, "Was May 14 a consequential moment for this market, at least tactically?" That date, nearly six months ago, was when the S&P 500 spurted higher to reach the 7500 level for the first time; the index has never reached escape velocity since and in fact crossed above 7500 again just yesterday.
May 14 was when highly touted AI-chip upstart Cerebras came public and its shares more than doubled to a high of $386, as President Trump and China's leader were reported to have made progress on ending the Iran war. Since then, Cerebras has collapsed to $97, the semiconductor group is off 17% and the Iran conflict continues.
A month later the SpaceX IPO was another apparent culmination of New Era tech enthusiasm; it might not have been an important peak in AI excitement, but if it were the market action since would possibly resemble what we've seen since.
Perhaps a half-year reckoning period during which the market has refused to pay up for 30% annual earnings growth for two straight quarters is enough to build a new base constructed on more modest expectations. I've been focused on late-cycle tremors unsettling markets in the form of peak earnings growth, peak capex, peak index concentration, a tighter Federal Reserve and credit flareups. This all explains the market's multi-month stall, and they remain.
But it's important to remain open to the chance that these could end up amounting to mere mid-cycle turbulence, as Morgan Stanley chief investment officer Mike Wilson has been arguing.
First, though, the tape will need to show more progress than a nice, broad single-day comeback. Another rule of thumb holds that a rebound rally needs at least to carry above the 20-day moving average to prove that it's not merely a reflexive dead-cat bounce. This would require a 1.3% gain from Monday's close for the S&P 500, 3.7% for the Nasdaq-100 and 9% for the SOX.
Without pretending any clear sense of what the various Nvidia investigations will mean for its China sales, leadership or long-term earnings power, we can say for sure that the scandal arrived at a fairly opportune time for the market.
Valuations have been pounded to multi-year lows on persistent worry that current profits are unsustainable and the group remains vulnerable to any slowdown in data-center builds. This allowed, for a day, every other semiconductor stock to whistle higher as Nvidia lost some $200 billion in market cap on a blistering $80 billion in dollar-volume traded in the stock.
The S&P 500 as a whole, of course, has grown optically cheaper, too, with semis bolstering the projected earnings and investors declining to give the group credit for their sustainability.
The issue remains that less of those earnings are set to manifest as free cash flow as the hyperscalers spend manically. As this chart comparing the valuation gauges shows, the market looks a good deal less cheap on free cash flow than earnings.
A proper bull case for the market from here might be that the likes of Alphabet, Amazon, Meta and Microsoft will resume harvesting free cash flow, on which investors might place a higher multiple than they're willing to bestow on those hot but hard-to-trust chip makers. Not yet a provable argument.
Market Temperature Gauge
John Kolovos of Macro Risk Advisors on the latest reading: "While sentiment is dire, our concern is that technology is in a 'bad oversold' condition, where seductive bounces fail to produce lasting lows. Instead, the broader equity market may need to follow technology lower, with a more widespread capitulation ultimately needed to wash out weak hands and establish a durable bottom."
Around the Street
-This enjoyable and illuminating review in the New Yorker of James Gleick's "The Telephone: A New History" inevitably summons parallels between the advent of telecommunications and the current AI buildout. Huge privately financed infrastructure buildout, destabilizing new habits of interaction with technology and constant calls for government regulation in exchange for near-monopoly power. The book cites an AT&T ad from 1909 calling telephones "tools of 'civilization . . . one of the most powerful influences for broadening human intelligence.'"
-Moody's Analytics economist Mark Zandi has a helpful thread suggesting AI is so far adding more jobs than it's costing the U.S. economy. The main reasons are sobering though, with most gains coming from data-center construction and wealth creation for those who own AI-dependent stocks. Cold comfort for information-economy job seekers.
-Last week's election triggering a Democratic takeover of Congress brought comparisons to the 1994 "Contract with America" Republican sweep for its magnitude and message. That election, in Bill Clinton's first term, highlighted deep societal fissures and economic instability.
With hindsight, many view the '90s as a placid era of consensus and prosperity, but between the '94 backlash election, constant corporate downsizing, scare-mongering over Federal debt levels, the 1995 Oklahoma City bombing and discomfort with technological change, that decade hit many of today's narrative beats. This Chicago Fed paper, "The decline of job security in the 1990s: Displacement, anxiety, and their effect on wage growth" can fill in some blanks for those not around for it.
Market on Close
Happy fifth anniversary to the peak of a pandemic speculative-tech bull market. Not quite two months before the S&P 500 hit a top in January 2022 as the Fed prepared to choke off surging inflation, perhaps by causing a recession, several key retail-trader-driven subsectors peaked.
The third week of November 2021 was the relative-performance peak in Tesla, as well as the absolute top in Coinbase and the Wisdom Tree Cloud Computing ETF (WCLD).
The five-year lookback period is one of the few time spans shy of 25 years over which the Nasdaq Composite has not outperformed the S&P 500. It's a plus that the broad market can withstand such internal speculative blowoffs, though also a good reminder that the most fun pockets of the market don't stay that way forever.
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