Wall Street's wider weakness keeps AI trade rolling

AI-related stocks have been the driving force behind much of the S&P 500's returns, earnings, and capital investment growth since late 2022, especially in an environment where other sectors are underperforming. Recent downturns in the market have primarily impacted technology stocks, but investor confidence in the AI sector has allowed indices to recover swiftly.

Some analysts have raised concerns about the risks associated with a heavy dependence on technology, noting that the scarcity of viable investment alternatives keeps investors engaged in the AI market, despite the potential for increased volatility. In Orlando, Florida, the situation highlights that AI continues to dominate Wall Street's focus, with the lack of enticing options amplifying this reliance. This dynamic raises the stakes for a potential market correction, which could be severe when it occurs.

The significant influence of technology on U.S. equity indices is well recognized, but the impact of weakness in other sectors is less understood. Typically, when a market begins to appear overvalued, investors start reducing their exposure. While some of this has occurred recently, the adjustments have been relatively minor. Even in light of concerns regarding AI investment, investors remain committed to this sector, driven by the impressive performance of major tech companies. According to JPMorgan Private Bank, a select group of 41 AI-focused stocks has contributed to 75% of the S&P 500's returns, 80% of its earnings growth, and 90% of capital spending growth since the launch of ChatGPT in November 2022.

Technology and communication services, two sectors within the S&P 500, are projected to generate 42% of the index's anticipated $783 billion in earnings for the third quarter, with that figure expected to rise to 45% in the fourth quarter. Investors anticipate that these sectors will account for half of all earnings growth in 2023, while six other sectors will only contribute about 10%. The sluggish growth in other areas of the economy seems to be restraining a shift away from tech investments.

This context explains why market fluctuations tied to AI uncertainties tend to be short-lived. For instance, last Thursday saw the S&P 500 decline by 1.2% due to concerns over the AI investment craze affecting chip manufacturers. Interestingly, while the index fell, 337 of the 500 stocks within it actually gained ground, as noted by Deutsche Bank's Jim Reid. This marked the index's second-worst performance in a day where over 300 stocks rose, the worst being a similar day in January 2025 when a new AI model from China led to a significant drop in Nvidia shares.

Last Friday, the S&P 500 and Nasdaq closed at their lowest points in over a month, largely driven down by technology stocks. The Philadelphia Semiconductor Index experienced a 20% decline in just over two weeks, and shares of Meta dropped by 20% from recent highs following its announcement of a substantial $97.5 billion equity raise to fund its AI initiatives. For a moment, it appeared that a deeper, prolonged downturn in AI might be on the horizon.

However, both indices have begun to recover, spurred by Anthropic's recent massive IPO filing and a series of other tech fundraising efforts that seem to have reassured investors about the longevity of the AI boom. This reaction is somewhat perplexing, as an increase in equity supply typically would not be expected to boost prices.

It is clear that investors are facing limited alternatives. This earnings season could bring unexpected negative results from tech companies, which might force investors to shift to other asset classes or more conservative stocks. HSBC strategists have recently adopted a more cautious stance, reducing their equity position to neutral.

A decline of 10% or more in the S&P 500 might not be far-fetched, though such occurrences are rare. Over the past four years, the benchmark U.S. equity index has only faced one downturn exceeding 10%, which happened between February and April of last year, largely due to market reactions to former President Donald Trump's tariff policies, culminating in a 20% drop.

History indicates that markets can continue to rise even amidst significant warning signs. Alan Greenspan, the former Federal Reserve Chair, famously referred to the “irrational exuberance” of the U.S. equity market in 1996, long before the dotcom bubble burst. The current AI boom may very well persist longer than skeptics predict, especially given the lack of alternatives. Notably, when HSBC revised its equity outlook, it suggested that any upcoming dips could represent good buying opportunities.

Nonetheless, the prevailing “there is no alternative” mindset can only sustain the “fear of missing out” sentiment for so long. Eventually, this cycle of boom could turn into a cycle of bust.

These insights are shared by Jamie McGeever, a columnist for Reuters.