Halloween with a delay

• Enguerrand Artaz
  Strategist
  La Financière de l’Échiquier (LFDE)

The impact on the financial world is usually limited to a few sweets shared amongst colleagues and a pumpkin or two decorating an office. This year, however, the markets seem to have decided to relive Halloween a few days later. Following the US mid-term elections, which saw the Democrats regain control of both houses of Congress, US shares – particularly tech stocks – suffered a veritable bloodbath that Stephen King himself would not have disowned. On Thursday 5 November, the Nasdaq 100 plunged by 6.4 per cent – its worst session since the Covid crisis – whilst the SOX semiconductor index crashed by 12.2 per cent, recording the second-biggest fall in its history, after that of 16 March 2020. There is no shortage of superlatives to describe this trading session, which spread to the rest of the global markets, starting with those most exposed to the AI ecosystem, such as South Korea. At the root of this bloodbath was a build-up of fears to which investors eventually succumbed. 

Fears over data centres, first and foremost. The ‘blue wave’ in the mid-term elections has reignited fears of a series of roadblocks to the development of this infrastructure, which is essential for AI, with many Democratic candidates having campaigned on their commitment to introduce moratoriums to restrict and limit the construction of new capacity. The issue is particularly sensitive in Texas. In this state, which accounts for 27 per cent of the computing capacity already built or due to be built in the United States, two Democrats were elected, including Gina Hinojosa, the party’s leading voice on the issue of data centres. The new governor wasted no time in putting her words into action: the day after her election, she called for a suspension of any decisions regarding public land near the SpaceX site at Starbase, which could be sold to Elon Musk’s company. Whilst no large-scale moratorium has been introduced as yet, the decisions taken in Texas could therefore have national implications and significantly impact the financial markets, with direct consequences: hyperscalers and AI laboratories could be forced to slow the pace of investment, leading in turn to a downward revision of the outlook for sectors dependent on such investment, such as chip and memory manufacturers or new cloud providers, which have seen spectacular stock market gains in recent years.

Next came fears over AI financing. A thorn in the side of the markets for several weeks, this issue took a new turn after a rumour sent shockwaves through Wall Street on Thursday evening, suggesting that a struggling alternative fund manager was being forced to sell a block of loans linked to data centres. Later, Bloomberg revealed that the firm in question was ING, which was seeking to sell around $500 million worth of data centre-related loans via an auction process, with bids expected on 19 November. Whilst the amount is modest on a market-wide scale and there is no indication that the bank is in difficulty over these loans, it is nonetheless an unusual move, coming at a time of widespread scepticism regarding the financing of AI infrastructure.

Fear of being caught in the trap, in short. Faced with the market’s accelerating downturn, many investors, particularly retail investors, have sought to sell their positions. However, a significant number of these positions were held via leveraged ETFs, which had seen record subscription volumes – $15 billion according to Bloomberg – in October. The massive panic selling of these leveraged instruments amplified the market decline, particularly in AI-related sectors, which are heavily held by retail investors.

Episodes of market capitulation are frightening due to their characteristic brutality. Driven by fear, they tend to amplify it but regularly turn out, in hindsight, to be attractive entry points to re-enter the markets. It is far too early to know whether this will be the case for this particular episode, especially as the underlying concerns are legitimate. In any event, this episode serves as a reminder that, when it comes to both market trends and asset allocation decisions, the future of AI remains by far the key determining factor.

__

Disclaimers: These data and opinions from LFDE, as well as the sectors and securities mentioned, are provided for information purposes only and, as such, do not constitute an offer to buy or sell any security, nor do they constitute investment advice or financial analysis. The sectors and securities are cited by way of example. Their inclusion in the portfolio is not guaranteed. Past performance is not indicative of future results and is not consistent over time.