Wall Street’s Wider Weakness Keeps AI Trade Rolling: McGeever

ORLANDO, Florida - AI remains the only game in town for Wall Street, and a lack of attractive alternatives is perpetuating this reliance. That risks making a crash all the more likely and painful when it comes.

The concentration of US equity indices in tech is well known, but less appreciated is how weakness in other sectors is helping drive this phenomenon.

Normally, when a market boom starts to seem a bit top-heavy, investors begin trimming exposure. While that has happened to some extent recently, the moves have been modest.

Despite the red flags around AI spending, investors are not giving up on the trade. Little wonder: Big Tech's recent track record has been exceptional. A group of 41 AI-related stocks has accounted for 75% of S&P 500 returns, 80% of earnings growth and 90% of capital spending growth since ChatGPT launched in November 2022, according to JPMorgan Private Bank.

Technology and communication services, just two of the S&P 500's 11 sectors, are expected to deliver 42% of the entire index's forecast $783 billion in third-quarter earnings, according to LSEG. That share is expected to rise to 45% in the fourth quarter. Investors expect these two sectors to account for half of all earnings growth this year, with six sectors contributing just 10%.

Tepid growth in other parts of the economy appears to be keeping a lid on rotation out of tech.

THIS TIME IS DIFFERENT?

This helps explain why market turbulence driven by AI jitters always seems to be so short-lived. Take the last few days.

Last Thursday, the S&P 500 fell 1.2% as worries over the AI investment frenzy slammed chip stocks. That was notable less for the scale of the decline than for its remarkably narrow breadth.

While the index fell, 337 of the index's 500 stocks actually rose, according to Deutsche Bank's Jim Reid. Indeed, of the nearly 3,000 days over the past three decades in which more than 300 stocks rose, Thursday was the index's second worst performance.

Curiously, the worst was January 27, 2025, when China's low-cost AI model DeepSeek burst onto the scene, sparking a record 17% crash in Nvidia shares.

This is yet another reminder – as if investors needed one – of the risk that market concentration can pose. By Friday, the S&P 500 and Nasdaq had closed at their lowest levels in over a month, pulled down by tech. The Philadelphia Semiconductor Index plunged by 20% in a little over two weeks, while Meta, which reported earnings last week, saw its shares fall 20% from their recent peak as investors were unnerved by the hyperscaler's plan for a record $97.5 billion equity raise to help fund its beefed-up AI spending binge.

Not for the first time this year, it looked like we might be seeing the beginning of a deeper, more prolonged AI slide.

But both benchmarks are already rebounding. On the surface, the catalyst appears to be Anthropic’s massive initial public offering (IPO) filing on Monday and a host of other tech fundraising, which have apparently given investors confidence that the AI boom still has legs.

Yet that’s puzzling, given that added equity supply would not normally be expected to boost equity prices.

Once again, the alternatives for equity investors may simply be limited.

NO CORRECTION HOME

Of course, this earnings season could deliver a major downside surprise in the tech space that triggers a more durable reversal, even if investors are forced to flee to other asset classes or low-growth defensive stocks. HSBC strategists have turned cautious and, on Monday, cut their maximum overweight equity position to neutral.

A decline of 10% or more in the S&P 500 wouldn't seem unreasonable. But it would be a rarity.

In the last four years, the benchmark US equity index has only experienced one downturn of more than 10%. That was from February to April last year, when President Donald Trump's “Liberation Day” tariffs spooked markets, culminating in a 20% fall.

History shows that markets can continue rising even when alarm bells are loud and clear. Former Federal Reserve Chair Alan Greenspan famously called out the “irrational exuberance” of the US equity market in 1996, years before the dotcom bubble actually burst.

The current AI boom could certainly outlast many doomsayers, given the slim opportunities elsewhere. It’s notable that when HSBC changed its equity stance, it also said that any dips in the coming weeks "will likely be a good buying opportunity."

But the “there is no alternative” trade can only fuel the “fear of missing out” trade for so long. At some point, this boom loop can become a doom loop.

(The opinions expressed here are those of the author, a columnist for Reuters)

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