The AI Hype Machine Got A Wall Street Reality Check This Week

As BB King once sang, "the thrill is gone." While the Silicon Valley hype machine goes into overdrive, taking the position that already extreme capital expenditures are actually not extraordinary enough, investors are asking tough questions about how the companies spending all that money are going to pay for it in the real world, as opposed to the fantasy land inhabited by AI executives (which is fueled by other people's money and expectation of FOMO-addicted greater fools buying them out before a crash - or a credulous government bailing them out after one).  

As incensed as the CEOs of Palantir, et al may be at the end of this phase of the game, it is apparent that a new phase has begun. JL

 
Sam Goldfarb and Hannah Lang report in the Wall Street Journal:

The tech heavy Nasdaq Composite Index, long buoyed by excitement over AI, had its worst week since President Trump unveiled his plans to impose tariffs on the rest of the world. Some of the biggest beneficiaries of that rally fell sharply amid concerns of overspending, and overpromising, on AI initiatives. Lofty stock valuations and private-sector surveys showing waning consumer sentiment and mounting job cuts added to the stress. Silicon Valley’s largest companies are planning to spend $400 billion on AI this year and even more next year. "People question, you’re spending that much money? How are you going to monetize that?”

Investors’ confidence in the outlook for the economy and the artificial intelligence boom has powered stocks to record highs. Their faith is wavering.

The tech-heavy Nasdaq Composite Index, long buoyed by excitement over AI, had its worst week since President Trump unveiled his “Liberation Day” plans to impose tariffs on the rest of the world. Some of the biggest beneficiaries of that rally fell sharply amid concerns of overspending, and overpromising, on AI initiatives.

At the same time, other perilous crosscurrents in the economy had Wall Street on edge. A government shutdown dragged into its second month, halting the flow of economic data that might have eased investor anxiety. Instead, lofty stock valuations and private-sector surveys showing waning consumer sentiment and mounting job cuts added to the stress.

“Valuations are stretched,” said Jack Ablin, chief investment strategist at Cresset Capital. “Just the slightest bit of bad news gets exaggerated…and good news is just not enough to move the needle because expectations are already pretty high.”

The Nasdaq fell 0.2% on Friday. The index’s weekly decline of 3% was its steepest since April. 

The S&P 500 ticked up 0.1% Friday but finished down 1.6% on the week. The Dow Jones Industrial Average added 0.2%, or 75 points, on Friday to end the week down 1.2%. 

In the tech world, the week opened on a promising note after Amazon.com’s $38 billion computing deal was cheered by investors. But AI darling Palantir Technologies’ quarterly results failed to impress Wall Street, while caution crept into the AI trade more generally, as investors started to wonder whether massive investments by tech companies will pay off.

Investors punished some of this year’s biggest winners. Palantir—which has more than doubled in price this year—fell 11% this week. Nvidia stock dropped 7%, while Oracle lost 9%. 

Investors were initially encouraged last week by Amazon and Alphabet results even as they were disappointed by Meta and Microsoft. Only Amazon eked out a gain this week, while Meta and Microsoft both fell around 4%.

The challenge for investors is figuring out how much leeway to give businesses. Silicon Valley’s largest companies are planning to spend $400 billion on artificial intelligence this year and even more next year, arguing that the investment is necessary to make AI tools even more effective.

People contin ue to question—gosh, you’re spending that much money? How are you going to monetize that?” said Thomas Martin, senior portfolio manager at Globalt Investments. 

A few prominent market voices also lessened investors’ AI enthusiasm. Michael Burry, of “The Big Short” fame, placed bets that would pay off should shares of Nvidia and Palantir fall.

At a summit in Hong Kong on Tuesday, Wall Street leaders including Goldman Sachs Chief Executive David Solomon and Morgan Stanley CEO Ted Pick opined that a pullback in markets seemed possible—even likely.

“Of course it is likely there’ll be, you know, a 10% to 20% drawdown in equity markets sometime in the next 12 to 24 months,” Solomon said at the event. “And I’d say there are very few people in this room that don’t think that that’s a meaningful possibility.” 

Wall Street didn’t get the benefit of Labor Department jobs numbers on Friday. Richard Drew/AP

Companies such as Microsoft and Alphabet are cash-generating behemoths that bear little resemblance to the unprofitable companies that characterized other frothy market cycles such as the dot-com bubble of the late 1990s. But investors are still uncertain whether their spending on AI will be worth the cost.

Stocks pared some losses on Friday afternoon after Senate Democrats made a new proposal to end the government shutdown. A potential deal didn’t arrive in time to rescue the Labor Department’s monthly jobs report, which had been scheduled for Friday morning. 

Instead, investors were left to focus on the latest reading from the University of Michigan’s consumer sentiment index, which fell to 50.3 in November from 53.6 last month. It marked the index’s lowest reading since mid-2022, during the worst of the pandemic-fueled inflation surge.

On Thursday, Challenger, Gray & Christmas said that U.S. companies’ job-cut announcements had nearly tripled in October.

“You have these macro factors that were effectively making some noise for a while, but nobody really wanted to listen,” said David Miller, chief investment officer at Catalyst Funds. “The consumer sentiment numbers and the employment numbers weakening—it’s forcing people to look at the bigger picture.”

Other data released this week was more encouraging, including a better-than-expected reading on monthly job growth from the payroll-processing company ADP. An index of service-sector activity based on a survey of purchasing managers also climbed to its highest level since February. 

The conflicting data whipsawed yields on U.S. Treasurys, which are heavily influenced by investors’ expectations for short-term interest rates set by the Federal Reserve. 

The yield on the benchmark 10-year U.S. Treasury note settled Friday at 4.092%, according to Tradeweb, down from 4.100% a week earlier. 

Interest-rate futures showed Friday afternoon that traders saw a 66% chance that the Fed will cut rates at its December meeting, according to CME Group, up slightly from a week earlier.