A Correction or a Fall?

By conventional indicators, the valuation of technology stocks has risen this year to take them into bubble territory. Valuations that reached multiples of forward earnings scarcely seen before indicated that they were priced for perfection. So a fall in valuations since mid-October was not a surprise.

This dip may reflect caution and profit-taking. It may presage a bigger fall, or it may be a pause in a long bull market accompanying the AI revolution. The indicators are not all pointing in the same direction.

So far, the stock market slide is just a correction. Markets fell in the first week of November. 

They nudged upwards in the week commencing Monday 10th, but then fell at the end of the week. 

The market as a whole remains at elevated levels compared with April, when there was a drop associated with President Donald Trump’s announcement on tariffs. 

To take just one example: Nvidia fell around 10% in the first week of November, but it was still around 60% higher than it was just six months earlier. 

The S&P 500 dipped to 6,700 on 14 November, which compares with a high of 6,920 but a low of 4,835 over the previous 12 months, and remains nearly 70% higher than November 2022.

 The dominance of large technology companies in aggregate market valuations has become pronounced. 

By the end of October, while the S&P had risen through most of the year, during that period some 397 of the stocks actually fell in value. Eight of the 10 biggest stocks in the S&P are tech firms. They account for 36% of the entire US market value, and 60% of the gains since April.

Palantir Technologies, a business applications software specialist, reached a peak valuation of 230 times future earnings.

 In early November, it was revealed that prominent hedge fund manager Michael Burry took a $912mn position against Palantir, whose stock has fallen from over $200 per share to around $170, though remains more than 150% higher over the year. Mr Burry later closed his hedge fund Scion Asset Management.

There has been an uneven pattern to the sell-off, following earnings reports in late October. Meta, the owner of Facebook, fell 12% over concern of its high investment levels in AI, given disappointing returns from its investment in virtual reality, though has recovered slightly. 

Alphabet, the owner of Google, rose 3%, though has since dipped by around 5%, and Microsoft fell by just 3%, then fell further before a partial recovery.

Unlike the dotcom start-ups of 25 years ago, the tech firms have strong revenues and a sound business model. Their services extend far beyond AI, covering business application software and cloud computing. In the case of Amazon, it is a general retailer as well as a tech firm. A strong argument is that much of the investment in AI is from large, profitable companies with a strong cash position.

The hyper-scalers, Amazon, Meta, Alphabet and Microsoft, all have strong underlying global businesses. 

The scale of the investment in data centres being planned has caused some investors to be concerned, however. 

Some tech firms have been issuing bonds; for example, in late October Meta announced a $25bn bond issuance to finance AI investment, following Oracle’s $18bn bond sale in September.

 In early November, yields on big tech firms’ bonds started to rise. Oracle’s stock suffered bigger falls in the middle of November, with investors concerned over debt, heavy reliance on OpenAI, negative free cash flow. It emerged that the outgoing CEO Safra Catz sold $2.5bn of Oracle shares this year.

Also, 10 loss-making AI specialist start-up companies have between them been valued at nearly $1tn, while there have been patterns of circular financing, especially concerning OpenAI.

Another dimension is that there is softening economic data from the wider economy. With the US government lockdown entering its second month, there has been no official jobs data since 5 September. Analysts and economics have been relying on private sources. Data from the private company Challenger, Gray and Christmas showed the highest level of October job lay-offs since 2003, while the payroll company ADP reported that US companies shed 32,000 jobs in September, the biggest fall in two and a half years.

Earnings from mainstream businesses have disappointed. The stock of the popular restaurant chain Chipotle fell 13% in late October following disappointing quarterly results.

The price of bitcoin has been unpredictable in recent weeks. It often rises in a counter-cyclical manner, increasing as stock market falls, but cryptocurrencies generally were off their highs at the time of the wider market correction. Bitcoin fell from around $125,000 on 7 October to just below $100,000 by mid-November. Many bitcoin investors are leveraged, and some forced, automated sales are likely to have occurred, accelerating and drop in price. Gold has fallen from a high of $4,400 per ounce to around the $4,100.

The AI investment industry is one of the few sectors to be registering growth, so if technology firm leaders fall short of their ambitions, the impact would ripple outside the industry.

Against that, the bearish commentators point to the relatively narrow foundation of asset price investment, and debt and macro-economic fragility in the higher-tariff era, a combination that compares unfavourably with the more benign macro-economic picture of 2000-2001.

The emerging technology of AI comes during an extended period of cheap money and globalisation, including of retail investing, and rapid growth of private credit. The worldwide exposure of investors to US stocks are part of a highly inter-connected system. 

High levels of government debt limit the extent of any fiscal stimulus following a shock. A loss in market value of the same proportion as the dotcom crash would have a far bigger impact on the real economy. The economist Gita Gopinath has estimated that it would cause a loss of $20tn for US households, or 70% of GDP. Foreign investors might lose $15tn.

There are two dimensions to risk assessment: Likelihood, and impact. The likelihood of an asset price collapse that is equivalent in proportional terms to that of the dotcoms would not appear to be high, although it is possibility. The impact would be seismic, and felt across the global economy.

The author is a Qatari banker, with many years of experience in the banking sector in senior positions.