AI Stocks Flounder

Last week artificial intelligence (AI) stocks fell off their perch, while the bottom-feeding low-beta and interest-rate-sensitive stocks finally began to swim upstream. It was a surprising crosscurrent to market action in the last two months when the rising tide of AI optimism buoyed tech stocks while most other sectors sank. As of the end of the previous week, only two sectors were showing net gains over the prior five weeks: technology (+6.14%) and energy (+1.59%). All nine of the other sectors were underwater over that stretch, with real estate (-5.28%), materials (-5.74%) and financials (-5.80%) the biggest sinkers. Last week, tech tanked 7.70%. Only three other sectors had losses (communication services, consumer discretionary, and industrials); all fell less than 1%.

In another gauge of how last week’s market action was a different kettle of fish, consider that for each of the prior eight weeks, there were more declining issues on the New York Stock Exchange (NYSE) than advancers. And in seven of those weeks, there were more new 52-week lows than new highs, in six of those weeks, significantly more new lows. Yet the broad averages, especially the tech-heavy indices, were nibbling at record highs. Despite last week’s losses, the NYSE was able to land more advancers than decliners and more new highs than new lows.

For the week, the S&P 500 Index (SPX) lost 1.95% and the NASDAQ Composite Index (COMP) sank 4.48%. Even with the losses, both indices weighed in with year-to-date (YTD) gains of about 12%. After ending the previous week within just one-third of 1% of its record intraday high, SPX merely trolled sideways through the first two sessions last week. Tuesday featured earnings announcements from several big banks, which were met with less than enthusiastic reactions.

The relative calmness of the first two sessions gave way to more stormy activity on Wednesday. The day began with the Consumer Price Index report for September coming in a tick or two above expectations on both the headline and the core readings. The stock indices all gapped down at the opening and continued lower for most of the session. SPX lost 1.11% that day and COMP fell 1.88%. Bond yields spiked higher on the news, with the 10-year Treasury note yield briefly climbing above 5.33%. But that yield fell back through the day, as weakness in tech stocks spawned a rush into the safety of Treasuries, ending at its lowest level since late September.

Thursday brought more disappointing inflation data. The report on the Producer Price Index (PPI) for September showed a bloated increase of 1.3%, well above August’s 0.4% increase and above consensus expectations of 0.6%. That’s the fattest increase in monthly PPI in more than four years. Flight-to-safety buying swamped the inflation news. The 10-year T-note yield reeled in its largest single-day decline in more than a year. That yield plummeted a bit more than 10 basis points to below 5.09%. Following a gap-down opening, stocks trended higher through the day as the lower interest rates outweighed the inflation news. COMP edged 0.08% higher for the day, and SPX gained 0.33%.

Those small gains were quickly erased on Friday as widespread weakness in AI stocks flowed into other high-beta sectors. Unlike the reversal of early weakness that stocks enjoyed in the prior session, Friday was an all-day rout – hook, line and sinker. Several of the low-beta sectors landed substantial gains on Friday, led by energy’s +2.52%. That sector trended higher all week as front month West Texas Intermediate crude oil futures rallied from below $90 per barrel on Monday to over $102.

Increasing concern over the quality of the debt that AI companies have been taking on (in the hundreds of billions of dollars) seemed to be the chum that lured the sharks that sank their teeth into AI stocks last week. The price of bonds tied to data center companies, especially the most indebted and riskiest companies, came under aggressive selling pressure. Also roiling the waters were some fishy revenue numbers and delayed initial public offerings from a couple of the leading private AI companies.

Most obvious among the crappie performers was CoreWeave (CRWV). The recently higher yields on long-term Treasuries imply a higher cost of future financing for AI companies that are issuing debt to finance data center buildouts. CRWV is a highly leveraged company, and its bonds, which are rated just one notch above junk, are now commanding yields of around 14%. Its stock declined about 24% last week and is now down about 55% over the last five months. Holy mackerel!

Only about 30% of the S&P technology sector stocks were able to land net gains for the week. Ten of the sector’s 75 component stocks had losses of 19% or more. Among the sector’s big fish with big losses last week were Hewlett Packard Enterprise Co. (HPE, -24.95%) and Dell Technologies, Inc. (DELL, -22.92%). A cast of semiconductor stocks also got speared. One popular measure of that group’s performance, the NYSE Semiconductor Index (SOXX), fell 9.44% last week. Friday’s loss of 4.1% added to its stringer of, now, nine consecutive losing sessions, its longest such streak since 2008.

Thankfully, the biting was better on the other side of the boat. Previously lagging sectors, including staples, healthcare, materials and even utilities, landed solid gains last week. Several of those sectors have underperformed for the past couple of months and now represent a target-rich environment for the bargain-hunting angler.

The first big week of the new earnings season is at hand. Approximately 75 S&P companies are due to report. Consensus estimates anticipate a year-over-year increase of about 27%. The vast majority of that growth will come from AI-related and energy companies. GE Aerospace, General Motors and Netflix are the big fish scheduled to report on Tuesday. Wednesday’s catch is even bigger with reports from Meta, Tesla, IBM and Lam Research.

The losses in SPX and COMP last week dropped both indices below their 50-day moving averages. For SPX, it’s just the third such violation in the last six months. On both prior occasions, the index bobbed back above the 50-day in the next trading session. The extent to which and the amount of time, if any, that SPX spends below its 50-day in the weeks ahead should be a good indicator of the months ahead. If weakness persists due to earnings reactions or midterm election anticipation, the key level for SPX to hold is its September low near 7508.

Other than the employment numbers on Thursday, there’s not much on this week’s economic report calendar that’s likely to produce any significant market reaction.

Links to previously published commentaries can be found at benjaminfedwards.com/Library/Market Commentary

6033943 EXP. 10/31/2029