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Fact really is sometimes stranger than fiction. You could hardly make up the events of the past week in global stock markets. As if the dramatic reversal in US politics last week were not enough, investors have since had to price in a tumultuous rout in AI stocks and then, this week, a potential international spy scandal involving the head of the sector’s most important company.
Nvidia plunges
This week’s instalment in the AI soap opera came straight out of a spy novel or TV box set. Jensen Huang, Nvidia’s chief executive, admitted an affair with a Chinese woman that US officials believe may have been working as a Chinese spy.
Unsurprisingly, given the importance to the company of its leader of 30 years, Nvidia’s shares plunged in pre-market trading on Monday. It was just what the sector was not looking for, as prices started to stabilise after last week’s post-election rout, the most significant setback so far in the four-year AI boom.
End of the AI boom?
Last week was the most difficult for investors in quite some time, as the market’s relaxed response to the Democratic landslide in the mid-terms soured after barely a day. By Thursday, investors were viewing last week’s political reversal as potentially bad news for a sector that had received uncritical support from the Republican-dominated administration.
In particular, big wins by some Democrat governors more attuned to public anxiety about the rapid build out of data centres in states such as Texas cast doubt on the massive AI spending that has boosted US GDP and supported a four-year equity bull market.
Thursday saw the Nasdaq fall 5.5%, with the US sell-off spilling over into Asian semiconductor manufacturers and, to a lesser extent, into European equities.
Three concerns coalesced during a painful 24-hour rout. Worries about whether massive spending will ever deliver commensurate returns for the big spending hyperscalers. Concerns about how the spending boom will be financed in an environment of higher interest rates. And whether a changed regulatory and political backdrop will support the AI revolution.
By Friday, things had stabilised. Nasdaq rose by around 1%, but the S&P 500 is still 6% below its October peak. The question remains how much the AI sell-off will infect the broader market.
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Inflation back in focus
Meanwhile, the market’s other main concern - inflation and interest rates - is back in focus.
Last week closed out with a much stronger than expected non-farm payrolls employment report. 165,000 new jobs in October compared with forecasts of around 60,000. Following the report, the probability of a December rate hike in the US rose to 81%.
This week attention shifts to the US CPI report tomorrow, with headline prices expected to be 3.9% higher than a year ago. That’s twice the Fed’s 2% target and would cement expectations of further tightening.
Here in the UK, rates did rise last week. The Bank pushed the base rate to 4% as it warned of a 5% peak in inflation next year and said growth would be slower than expected. That raises the spectre of stagflation, the toxic mixture of stagnant growth and persistently higher prices.
One possible counterweight to the inflationary surge could come from the oil price as hopes rise for US-Iranian talks to end the conflict in the Gulf. Brent crude, which has been trading close to $120 a barrel, is now back below $100.
Normal service resumes for bonds
Meanwhile, bonds have returned to their traditional role of delivering an uncorrelated response to negative news for equity investors. As shares tumbled last week, the yield on government bonds fell, pushing bond prices higher.
The 10-year US Treasury yield peaked at 5.36% a few weeks ago and has retreated to around 4.8% currently. That’s not too surprising given the obvious value in bonds at those elevated yields and investors have been quick to lock in a high and secure income when the returns from shares have been so uncertain.
How long this will persist is less clear. If inflation remain high, and interest rates start to tighten again, it is hard to see much further appreciation for bonds. Investors looking for diversification away from equities, will have to look further afield than fixed income.
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