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Key Takeaways
- Tech stocks led the major indexes lower on Thursday as investors turned their attention from the longest government shutdown in U.S. history to concerns about an AI bubble.
- Investors are increasingly concerned that massive spending on data centers is fueling an unsustainable AI boom that could be a bubble.
- Meanwhile, Wall Street’s expectations for a December rate cut are fading.
The stock market cleared a major hurdle this week. It’s the outset of what is historically a good time for equities. You wouldn’t know it if you looked at your portfolio today.
President Donald Trump on Wednesday signed legislation to reopen the federal government, ending the longest shutdown in U.S. history. The reopening removes the economic drag from more than 1 million federal workers going without pay and clears a path for federal agencies to once again release vital economic data.
Yet stocks were falling Thursday, led by the tech-heavy Nasdaq, which finished the day down more than 2%—perhaps a “buy the rumor, sell the news” event, since stocks rallied on Monday as an end to the shutdown looked imminent.
Why This Matters to Investors
AI optimism and expectations for rate cuts have been two of the primary drivers of stock returns this year. If either AI or the Federal Reserve fail to meet Wall Street’s expectations, stocks may be vulnerable to correction.
Historically, the end of a shutdown has supported stocks, according to Adam Turnquist, Chief Technical Strategist at LPL Financial. Since 1976, he wrote Wednesday, covering 20 shutdowns, the S&P 500 has risen more in the one- and three-month periods after a budget resolution than in all other comparable periods.
This shutdown is also ending at a time of year that’s historically good for the stock market. Since 2000, November has, on average, been the best month of the year for the S&P 500. December, another positive month, is more often than not capped off with a Santa Claus rally.
But the mood on Wall Street heading into the end of the year appears more dour than rosy, with investors debating the existence of an AI bubble and uncertain what incoming economic data will say about the health of the economy.
Bubble Fears Are Weighing on Tech Stocks
The debate about an AI bubble has taken a toll on tech stocks in recent weeks. Shares of chipmaker Nvidia (NVDA) slid 7% last week, and were down more than 3.5% on Thursday. Palantir (PLTR) stock tumbled 8% the day after it posted earnings that blew past estimates and raised its full-year guidance. On Thursday, the majority of the S&P 500’s worst-performing stocks were high-flying AI beneficiaries like software firm Applovin (APP) and chipmaker Broadcom (AVGO).
AI bubble concerns are being fueled by soaring valuations in both public and private markets. OpenAI, which doesn’t expect to turn a profit until 2029, is valued at $500 billion. Palantir, even with its recent pullback, trades at about 240 times forward earnings.
The chasm between AI spending and AI revenue has also raised eyebrows. Hyperscalers Microsoft (MSFT), Alphabet (GOOG), Amazon (AMZN), Meta (META), and Oracle (ORCL) intend to spend hundreds of billions of dollars to build data centers and fill them with AI-enabling equipment. They have had some success showing investors that AI is contributing to their top and bottom lines, but some investors are turning skeptical.
Wall Street has also taken note of a shift in how AI investments are funded. Up to this point, tech giants like Microsoft and Amazon have mostly relied on cash flows to build data centers and buy chips. Proponents of the AI bubble narrative have frequently pointed to the size and stability of these cash flows to argue for the AI boom’s sustainability.
Fed Rate Cut Hopes Are Fading
Investors will also be watching economic data heading into the Federal Reserve’s last policy meeting of the year next month.
Inflation and labor market reports were delayed by the shutdown, denying Wall Street and the Fed vital economic temperature checks. And, despite the end of the shutdown, investors aren’t sure when they’ll get that data, if at all. The White House on Wednesday suggested inflation and labor market data for October may never be released, which would leave policymakers to lean on other public and private datasets as they deliberate whether to cut interest rates for a third time this year in mid-December.
Officials are divided on how to proceed. Some have urged caution, citing concerns that inflation, which has reaccelerated this year, could stick above their 2% target. The data blackout has given inflation-wary officials even more reason to argue for slower cuts. Meanwhile, recent private sector data suggests that labor market conditions have deteriorated more than expected this year, giving dovish officials fodder to argue for more aggressive cuts.
Wall Street increasingly believes the hawks, who favor higher rates, have the upper hand. Federal funds futures trading data on Thursday put the odds of a December rate cut at 47%, down from 96% a month ago and 63% yesterday.
