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The Hire-No-Fire AI Economy
The stock market reacted to the Democrats’ midterm election sweep in zig-zag fashion, with a crisis-aversion relief rally on Wednesday, a plunge on Thursday as the thought of AI data center roadblocks chilled investor optimism, and a bit of a recovery Friday as leveler heads prevailed (speed bumps yes, roadblocks no). … Also: The AI race faces three intensifying constraints—financial, political, and physical, the first two becoming acute. Will the boom continue? Elias and Ed share why they think it will but at a slower pace. … And: AI is making, not taking, jobs—at least so far. They also share four cheery takeaways from the employment report for October. … Plus, Ed reviews “Tenzing” (+ +).
US SECTORS CALL: Information Technology, Industrials & Utilities
Last Thursday’s selloff in the stock market was an AI selloff. Investors dumped companies that build, wire, and power data centers, following the Democrats' sweep of Congress amid voter hostility toward new facilities. Stocks recovered some ground on Friday. October payrolls rose by 165,000, beating expectations of 65,000. Still, the S&P 500 ended the week down 2.7%, and Information Technology (MW) fell 6.9% (chart). Energy (OW) was the worst-performing sector this week, down 11.9%, for a different reason. Oil prices tumbled on hopes of a US-Iran peace deal following the midterm elections. We are retaining our overweight recommendation on Energy as a hedge against re-escalation. Consumer Discretionary (UW) and Communication Services (MW) led the week, up 2.7% and 2.3%. The market is pricing the AI backlash as a roadblock. We see a speed bump. Investors have already cut the multiples of the build-out’s suppliers. Analysts have yet to cut their earnings estimates. That is the next test. We are not changing any of our sector weights. Here’s more on Information Technology, Industrials, and Utilities: (1) Information Technology. The selloff hit the build-out’s hardware suppliers the hardest. Semiconductor Equipment fell 14.5% this week, followed by Semiconductors (-10.9%) and Communication Equipment (-9.4%) (chart). Semiconductor Equipment is the clearest case of a speed bump priced as a roadblock. The industry’s stock price index is 27% below its 200-day moving average (chart). Yet its forward earnings and forward profit margin are at record highs. Its forward P/E has dropped to 21.2 from about 52.3 in June. Analysts keep raising their estimates for Semiconductor Equipment stocks. Collectively, they expect the industry’s earnings to grow 35.4% this year and 51.5% next year (chart). Their consensus earnings estimate for 2027 has risen steadily all year. Semiconductor Equipment is one of only two IT industries for which analysts expect faster growth next year than this year. Valuations are far from tech-bubble extremes. IT and Communication Services together account for 47.6% of the S&P 500’s market capitalization and a nearly identical 47.1% of its forward earnings (chart). In 2000, when valuations were at tech-bubble extremes, their market-cap share far exceeded their earnings share. Tech's forward P/E has fallen to 17.3, and Semiconductors' forward P/E is down to 12.0. That already discounts some earnings disappointment. A modest cut in estimates is probably priced in. A deep one is not. That’s why we remain at a market weight rating. (2) Industrials. The AI-exposed industries led Industrials lower this week. Electrical Components & Equipment fell 9.1%, and Construction Machinery & Heavy Trucks fell 7.8% (chart). Passenger Airlines, Industrial Conglomerates, and Industrial Machinery all rose. Electrical Components shows the same disconnect as Semiconductor Equipment. Its stock price index is 13.2% below its 200-day moving average. Yet its forward revenues and forward earnings are at record highs, and its forward profit margin rose to a record 18.2% (chart). Analysts expect the industry’s earnings to grow 20.5% this year and 19.1% next year. Its forward P/E has fallen to 23.0 from over 30. The Construction Machinery & Heavy Trucks index is trading at 26% below its 200-day moving average, even as its forward earnings have risen to a record high. Elsewhere, Rail Transportation is up 24.4% ytd. Analysts have trimmed the sector’s 2027 earnings growth estimate to 15.8%, from 19.0% in July. That is still strong growth, and it supports our overweight rating. (3) Utilities. The gap between this sector’s best and worst performing industries is enormous (chart). The Independent Power Producers & Energy Traders industry stock price index is down 18.2% ytd, including a 7.8% drop this week. Water Utilities is up 15.2% ytd, while the Utilities sector as a whole is up just 1.0% ytd. IPPs sell power to data centers, and investors are pricing out that premium before analysts do. The industry’s forward earnings is up 8.4% ytd, while its stock price index is down 18.2% (chart). Its forward P/E has fallen to 10.0, and its forward profit margin is at a record high. Analysts are starting to follow investors’ lead. They cut their 2026 revenue growth estimate for IPPs to 15.7% from 21.6% over the summer (chart). But they still expect IPP earnings to grow 12.0% next year. The low valuation suggests that investors expect more estimate cuts. We downgraded Utilities to market weight on October 2 due to rising bond yields. The data center premium coming out of the IPPs gives us a second reason. We remain at a market weight rating.
GLOBAL MARKETS CALL: Air Coming Out Of AI Bubble
The AI selloff went global last week. In the US, Democrats swept Congress in the midterm elections on Tuesday, November 3, surfing on a huge wave of voter hostility toward new data centers. On Thursday, investors dumped the AI trade worldwide, and Asia’s chipmakers took the brunt of the wipeout. Overseas earnings are still climbing, but valuations keep falling. We see the AI backlash as a speed bump, not a roadblock, at home and abroad. Here’s more: I. Stock Market Performance Global sector leadership flipped this week according to the FTSE indexes (chart). Defensive sectors held up best, with Real Estate up 2.2% and Consumer Staples up 0.7%, while Consumer Discretionary led with a 2.7% gain. Technology (-6.7%) and Telecommunications (-7.4%) were near the bottom. Energy was the worst performer, down 10.4%, as fears of a post-midterm re-escalation in the Middle East faded. The FTSE World index fell 2.5%. The US has been gaining ground since we lowered our "Go Global" investment strategy to market weight on October 18. The US MSCI’s share of the All Country World MSCI’s market cap has climbed to 65.3%, up from 62.4% in March (chart). The gains have come at the expense of everyone else. The Emerging Markets MSCI’s share has dropped to 11.1% from 12.1% in mid-October. The AI-heavy markets were at the bottom of the country ETF rankings this week (chart). Taiwan fell 11.7% in dollars, South Korea 10.4%, and Japan 5.0%. This year’s laggards caught bids. South Africa led with an 8.5% gain, followed by India at 6.6%. The US ETF fell 2.7%, slightly worse than the All Country World ex-US ETF’s 1.8% decline. Both the US and overseas ETFs have pulled back from their recent highs (chart). Both remain in solid uptrends that began in late 2022. II. Stock Market Earnings & Valuation The All Country World ex-US MSCI’s forward earnings rose to yet another record high this week (chart). It has soared since 2025 after going nowhere for most of the previous decade. Forward earnings is up 41.0% y/y, while forward revenues is up 11.2% (chart). During solid economic expansions, forward revenue growth tends to hover around 5%. Today’s double-digit pace confirms an economic boom underpinning the global bull market. Valuations continue to fall even as earnings soar (chart). The US MSCI’s forward P/E is down to 18.9. Japan’s has dropped to 14.2 from 14.7 a week ago. The All Country World ex-US trades at 12.0. The Emerging Markets MSCI has slipped to single digits and is at 8.6 now. III. Bonds Sovereign bonds continued to rally worldwide this week as investors fled the AI trade (chart). The US 10-year Treasury yield fell to 4.86%. The UK's yield remains the highest in the group, at 5.16%, followed by Australia’s 5.00%. France’s yield has dropped to 4.77%, back below the US yield. Japan’s yield is down to 2.63%. IV. Focus on South Korea & Taiwan South Korea's forward earnings is still rising to record highs, though more slowly than earlier in the year (chart). The stock market isn’t buying it. The MSCI South Korea stock price index is down more than 45% from its record high. Its forward P/E has collapsed to 3.4, the lowest in over 20 years. Investors are betting that analysts will have to slash their earnings estimates. Taiwan tells the same story, but with a more sensible valuation. Its forward earnings is also at a record high. Its forward P/E has dropped to 14.4 from 23.2 earlier this year (chart). Fundamental data suggest South Korea and Taiwan should continue to benefit from US demand for technology hardware. US imports of selected technologies rose to a record $61.3 billion in September (chart). Asia supplies much of that hardware. US imports from Vietnam rose to $28.7 billion in September, and imports from Taiwan rose to $28.4 billion (chart). Imports from South Korea rose to $19.2 billion. A slower US data center buildout would delay that demand, not derail it. We would view a slower pace as more sustainable over a longer period of time.
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