Midterm Results Weigh on the AI Trade

A volatile week for AI-related stocks weighed on the major indexes. The S&P 500 fell 2.7%, the Nasdaq dropped 3.4%, and the Russell 2000 (an index of smaller U.S. companies) declined 2.0%. The Nasdaq’s steeper loss reflected a sharp sell-off in AI-related names. Still, the week appeared to reflectmore of a rotation than a broad retreat from risk. Energy dropped 11.9% as oil prices slid on reported progress in U.S.-Iran talks. The 10-year Treasury yield fell 8 basis points, helping the Bloomberg U.S. Aggregate Bond Index gain 0.4%.

Political shifts in Washington and several key states weighed heavilyon the AI trade. Stocks rallied Wednesday after Democrats won control of both chambers of Congress, as investors viewed the outcome as resolving a key source of uncertainty. That optimism faded Thursday amidconcerns that Democratic wins in key data center states, including Texas, could slow the AI infrastructure development through permitting delays and new restrictions. Texas, which has more planned data center projects than any other state, elected a governor who has called for new approvals to remain paused until the legislature meets next year.

The Nasdaq lost an estimated $2.5 trillion in market value Thursday, its largest one-day dollar loss on record, and closed in correction territory (down 10% or more from its recent high). For the week, the PHLX Semiconductor Index (SOX), which tracks major chipmakers, fell 12.2%, while the Roundhill Memory ETF (DRAM), which holds memory chip producers, dropped 18.2%. The sell-off also raised questions about valuations for AI companies preparing to go public. Anthropic, which is targeting an IPO the week before Thanksgiving, had been expected to raise up to $100 billion at a valuation of around $1.5 trillion. Following Thursday’s sell-off, major investors reportedly indicated that the valuation may need to be revised downward..

Third-quarter earnings season is nearing its end, and results have been strong. With 88% of S&P 500 companies having reported, the S&P 500 has a blended earnings growth rate of 31% for the quarter, which combines actual results with consensus estimates for companies that have yet to report. Economic data released Friday pointed to a resilient labor market. Employers added 165,000 jobs in October, well above the 59,000 economists expected, while the unemployment rate edged down to 4.1%. Gains were broad-based, led by professional and business services and healthcare, and prior months were revised higher. Markets are currently pricing in an 80% probability that the Federal Reserve will raise interest rates by 25 basis points at its next meeting in December.