The Stock Market's Losses Will Not Last, as AI Trade Comes Roaring Back

The artificial intelligence (AI) sector has faced some challenges in recent weeks, but according to John Higgins, chief market economist at Capital Economics, the downturn might be temporary.

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Higgins explained in a report shared with MarketWatch on Monday that the current situation resembles 1998 rather than 2000. In 2000, the dot-com bubble burst, whereas in 1998, there was a temporary pullback in share prices that coincided with a resurgence of the Japanese yen. He believes the stock market is likely to recover as the economy remains more robust than initially feared and investors renew their interest in AI.

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Earlier this year, stocks seen as major beneficiaries of AI technology drove significant gains in indexes like the S&P 500 and Nasdaq Composite, both of which hit record highs. Nvidia Corp., in particular, has been a standout, contributing substantially to the market's 2024 gains.

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Recently, however, these same stocks have led the market's decline from its mid-July highs. This downturn has been influenced by concerns about the U.S. economy's strength, particularly following some disappointing labor market data. Additionally, there are worries about whether substantial investments in AI-related infrastructure by companies like Alphabet Inc., Google's parent company, will ultimately be profitable.

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Higgins pointed out two additional factors contributing to investor anxiety. The first is the potential political impact if former President Donald Trump returns to the White House, which could lead to a backlash against Big Tech. Investors are also concerned about Trump's recent remarks regarding the U.S.'s defense commitment to Taiwan and the Biden administration's efforts to limit chip-making equipment sales to China.

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The second factor is the recent rebound of the Japanese yen, which might be causing some investors to unwind their positions in U.S. stocks that had become overextended.

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These factors combined present a scenario similar to 1998, when a slight increase in the unemployment rate was accompanied by a sharp rally in the yen. However, unlike in 1998, there is no systemic threat this time around. Back then, the collapse of the hedge fund Long Term Capital Management pressured the Federal Reserve to cut interest rates.

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Capital Economics anticipates that fears of a U.S. recession will eventually prove to be exaggerated.

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After the bell on Monday, there were signs that the AI trade might be regaining momentum, as shares of Palantir Technologies Inc. surged after the company exceeded Wall Street’s revenue growth expectations and raised its full-year forecast.

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Capital Economics previously noted that some of the enthusiasm for AI might be driven by hype. Nonetheless, this enthusiasm could still propel the S&P 500 to 7,000 by the end of next year, according to Capital Economics’ top economist, Neil Shearing, in a note shared with MarketWatch in early July.

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U.S. stocks declined on Monday, with the tech-heavy Nasdaq Composite dropping 3.4% to 16,200.08, marking its worst day since July 2022, according to Dow Jones Market Data. The S&P 500 fell 3% to 5,186.33, its worst day since September 2022. The Dow Jones Industrial Average decreased by 1,033.99 points, or 2.60%, to 38,703.27, also its worst day since September 2022.

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