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We Promised You Buying Opportunities After The Midterms
I. The Delayed Cold Shower Since September 15, we've counseled proceeding with caution in the stock market through the midterm elections. We anticipated buying opportunities after Tuesday's elections. Stocks rallied on Wednesday. But they plunged today. The S&P 500 fell 4.4%, its worst day since the April 2025 tariff shock (charts). The Nasdaq composite sank 5.5%, entering correction territory, while the Dow dropped 3.4% and the PHLX Semiconductor index plunged 12.0%. The cold shower we warned might follow a Democratic sweep arrived a day late. We believe that Wednesday's rally was driven by short covering as two key risks failed to materialize. First, investors feared President Donald Trump might contest close elections, potentially triggering a constitutional crisis. Instead, on Wednesday morning, he acknowledged the Democrats' decisive victory and said he is willing to work with them. Second, investors feared an immediate re-escalation of the war in Iran after the midterms. But oil prices fell sharply on Wednesday on reports that the US and Iran are pursuing a diplomatic solution. On Thursday, investors began discounting the implications of the Democratic sweep for the economy's golden goose: the AI investment boom. The political backlash against data centers is gaining momentum, with 76% of voters opposing new facilities in their communities, according to NBC exit polls. Perhaps most consequentially, Texas, which accounts for nearly 30% of planned US data center additions in 2028, elected Gina Hinojosa as governor after she promised to halt new approvals. Goldman Sachs estimates that states facing possible restrictions account for roughly 45% of planned US data center capacity. Tougher permitting and higher costs could delay billions in investment and postpone returns for hyperscalers. Given the AI boom's growing importance to economic activity, the implications extend well beyond technology. As a result, the 10-year Treasury yield fell another 7bps to 4.83% today, reflecting safe-haven demand and fears of weaker economic growth. Investors also pared back Fed tightening expectations, with futures pricing just 1.7 quarter-point hikes over the next 12 months (chart). We view the political backlash as another constraint on AI investment, alongside financial and physical bottlenecks. But these are speed bumps, not roadblocks, even though Wall Street seems to be pricing in the latter. We think that's overdone. As AI adoption broadens and productivity gains accelerate, demand for compute will keep growing. Data centers will get built, albeit at a slower pace. Speed bumps should prevent the AI boom from moving too fast and crashing around the next curve. That's why we view Thursday's selloff as a buying opportunity. Our favorite Boom-Bust Ratios likely turned even more bearish after today's selloff (chart). From a contrarian perspective, panic attacks tend to be bullish. Our Roaring 2020s scenario remains on track, and we are sticking with our 7,900 year-end S&P 500 target. Late-breaking news: Texas Governor-elect Gina Hinojosa was interviewed after the market closed on CNN and said, "All currently permitted data centers in Texas will be allowed to finish construction." This essentially covers all of 2027 and likely most of 2028. She plans to pursue legislation requiring newly permitted data centers to pay taxes, protect consumers from higher power prices, preserve water availability, use union labor, and give "Texans a seat at the table." II. On Productivity and Labor Market Conditions While Wall Street frets about a potential slowdown in the AI investment boom, the latest data show that productivity growth is already accelerating, even as AI adoption remains in its early stages. Here is more: (1) Productivity. Nonfarm business productivity jumped 3.6% q/q (saar) during Q3, the strongest pace since Q3-2025, while rising 2.1% y/y (chart). The seven-year productivity growth cycle is increasing by 2.4% annually, exceeding its historical average (chart). In our Roaring 2020s scenario, productivity growth is likely to rise to 3.5%-4.0% over the remainder of this decade. (2) Unit labor costs & inflation. Unit labor costs is measured as hourly compensation divided by productivity. It rose just 2.4% y/y in Q3-2026, reinforcing our view that the labor market is not currently a source of inflationary pressure (chart). (3) Unemployment claims. Initial jobless claims fell to just 189,000 during the week ended October 31 (chart). The four-week moving average dropped to 194,750, its lowest level since 1969! Continuing claims also remain low. The message is clear: The Fed has little reason to worry about the health of the US labor market. (4) Layoff announcements. Challenger reported just 44,000 announced job cuts in October, down 71% y/y and the lowest October reading since 2023, reinforcing the message that layoffs remain subdued (chart).
On Semiconductors, Neoclouds & Threats To Undersea Cables
Investors rewarded semiconductor maker AMD’s impressive Q3 earnings report, which reflected robust compute demand and expanding market share. Yet the S&P 500 Semiconductor industry at large has been out of investor favor for a number of possible reasons. … Also: Neoclouds may have a tougher time pursuing their data center aspirations, Jackie reports, given tighter credit conditions and now the midterm elections’ Blue Wave. Democratic leaders are much more likely to impose hurdles to slow the data center buildout. … And: Geopolitical strife has three nations threatening or preparing to cut the undersea Internet cables on which modern life as we know it depends.
Gridlock Won & Markets Cheer
I. Why Wall Street Is Cheering the Blue Sweep Ahead of Tuesday's midterm elections, we warned that a Democratic sweep of Congress could deliver a cold shower to Wall Street. It still could, but it didn't do so today. Democrats captured both chambers of Congress, flipping seven Republican-held Senate seats, including historic victories in Texas, Kansas, and South Carolina. Financial markets put a positive spin on the blue wave. Oil prices fell on hopes that the US and Iran are more likely now to resolve their war diplomatically. If so, then the outlook for inflation will improve. So the Fed might not have to raise the federal funds rate as much. The federal deficit might not widen further if Democrats refuse to increase defense spending, while President Donald Trump vetoes their attempts to provide Medicare for all. If Democrats slow the AI buildout, hyperscalers' profits and free cash flow will increase. Fewer AI-related bond issues would also help keep a lid on bond yields. Initially, Nasdaq-100 futures plunged as much as 2.4% overnight, while S&P 500 futures fell 1.4%. But the selloff reversed after Trump struck a surprisingly conciliatory tone, congratulating Democrats and saying he was willing to work with them. That is when the cheer on Wall Street started. The Dow surged 3.0% today, the strongest post-midterm rally since 1982. The S&P 500 jumped 1.6%, its best session in three months. The Nasdaq-100 advanced 0.9%. The relief rally extended beyond equities. The 10-year Treasury yield fell to 4.90%, back in what we have called the "old normal" range of 4.00%-5.00% (chart). The dollar index (DXY) fell more than 1.5%, its biggest decline since September. Gold rallied back above $4,000 an ounce. It might be finally bottoming. Brent crude plunged 8.7% to $94.62 a barrel amid hopes of Middle East de-escalation. The nearby futures price of gasoline plunged to $2.73 (chart). Investors may be warming up to the idea that some constraints on the AI buildout could be healthy, as we have been arguing recently. Democratic victories in key data center states, including Texas and Georgia, raise the prospect of tighter construction restrictions amid concerns about electricity and water consumption. Hyperscalers rallied today, with Amazon and Microsoft gaining more than 6%, as capital discipline could ease concerns about AI investment returns and improve free cash flow (chart). AI infrastructure providers struggled, however. The PHLX Semiconductor Index fell 3.1% amid fears of weaker demand from a slower buildout. We may be entering an AI Goldilocks zone, with enough restraint to take some air out of the bubble without derailing the boom. II. The US Economy Continues To Perform Well The economy and, therefore, earnings remain fundamentally resilient, which continues to support the bull market. With the midterms behind us and political uncertainty receding, investors can refocus on these strong fundamentals. Here are the highlights of today's upbeat economic indicators: (1) ISM Services PMI. The ISM-NM PMI edged down modestly to 54.5 in October, marking its 28th consecutive month of expansion (chart). Underlying demand remained solid, with new orders and business activity both comfortably above the 50.0 expansion threshold. Encouragingly, the employment index rose from 50.1 to 51.4, marking its second consecutive month of expansion. Inflation is still a concern. The ISM prices-paid indexes remained elevated in October (chart). (2) Labor market. The average of the ISM employment indexes rose to 51.9 in October, its highest reading in roughly three years (chart). ADP reported an 86,000 increase in private payrolls in October, beating consensus expectations of 67,000. (3) Trade balance. The latest trade data point to resilient US and global economic growth. Merchandise imports rose 2.4% m/m in September to a record $3.44 trillion annualized, while exports increased 2.5% m/m to $2.09 trillion. The merchandise trade deficit widened to $1.35 trillion annualized (chart). Nominal and real US merchandise exports plus imports rose 21.1% y/y and 10.1%, respectively, in September (chart). That suggests global trade remains firmly in expansion territory and is consistent with strong global economic growth. Selected technology imports reached a record $61.3 billion in September, reflecting the AI buildout’s heavy reliance on imported semiconductors, servers, and other hardware (chart).
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