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Market leadership broadened beyond technology in October, as investors rotated away from the largest AI-related stocks and into the broader market.
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Rising rates are challenging the economics of the AI boom, raising questions about the sustainability of hyperscaler spending and the timing and magnitude of returns on investment.
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Consumer strength remains uneven across income levels: Higher-income households continue to spend, supported by stock market wealth, while lower-income consumers are increasingly impacted by rising food and energy costs.
The concerns we’ve been expressing regarding the AI boom and the dominance of technology in the major indices became market drivers in October. The S&P 500 dipped -0.9% for the month, while the equal-weighted S&P 500 rose 5.0%. Some 70% of stocks in the S&P were positive. This reflects a massive rotation away from the Mag 7 and hyperscalers into the rest of the market. Small and mid cap stocks also benefited. Sector performance clearly illustrates this as well, with Technology and Communication Services falling -7% and -15%, respectively, the only negative returns within the eleven S&P sectors. Double-digit positive returns were generated by Energy, Consumer Staples, Utilities, and Health Care. The overarching concern remains the massive size of AI spending and the extent and timing of the potential return on this capital investment.
Interest rates and the bond market played a role as well. Not only do higher rates give investors an alternative to stocks, but data center development costs have long since exceeded hyperscaler cash flow, forcing them into the debt markets to finance their expanding investments. This is at a time when rising memory prices and growing grassroots antipathy to data center development projects are escalating costs. Higher Treasury and other sovereign debt rates provide investors with viable choices and have given some observers pause regarding the hyperscalers’ ability to raise the needed capital at a reasonable cost. Any pullback in data center expansion would reverberate throughout the economy since their construction and equipping have been a major driver of overall growth.
One bright note has been the solidity of the American consumer, even as consumer sentiment remains quite low. Some of this can be attributed to the persistent gap between higher earning households and lower earning ones. For instance, high gas and heating oil prices have a much larger percentage impact on lower-income households. The price pressures on gas and food show no signs of abating. In surveys, the lower income households report distress, while higher income households continue to spend behind the sustained wealth effect of the stock market.
In the meantime, the markets seem fundamentally indifferent to the November elections, probably because even a blue wave would leave the government divided. A deadlocked government is typically seen as a positive for stocks. In other news, concerns over the downsides of technological innovation were only heightened by the record-breaking hack of industry-leading cryptocurrency firm Binance. It’s still unclear how much AI was involved in the theft and laundering of the billions stolen. The losses, blamed on state hackers from North Korea, certainly sent a chill through investors who believed that the blockchain technology behind crypto made holdings inviolably secure.
Altogether, lessons from the month confirm some of our longstanding beliefs and concerns. The idea that index investing provides guaranteed diversification is belied by the S&P 500’s technology weighting. One of the major benefits of the active management we champion is recognizing the dangers of overconcentration and working to ensure investors are truly diversified.