Stocks Tumble as Wall Street Gets AI Wake-Up Call: Markets Wrap

(Bloomberg) — Wall Street got a reality check after a disappointing start of the megacap earnings season fueled concern the artificial-intelligence frenzy that has powered the bull market might be overblown.

A steep selloff in high-flying technology stocks sent the S&P 500 to its worst day since December 2022, ending its best stretch without a 2% decline since the start of the global financial crisis. Losses were more pronounced in the Nasdaq 100, which tumbled over 3.5%. Alphabet Inc. slid 5% after sinking more resources into its drive to outmatch rivals in AI, with spending higher than analysts expected. Tesla Inc.’s profit miss and the Robotaxi delay spurred a 12% stock plunge.

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“Investors are finally waking up to all that AI spend and realizing it is much more of an expense right now rather than a revenue generator,” said Peter Boockvar at The Boock Report.

Wednesday’s session was another lesson in the “concentration risk” bears see as latent in a market whose upside has owed disproportionately to a narrow cohort of massive gainers. For a fourth straight session — and the 10th time in 11 days — the performance of smaller companies exceeded larger ones, evidence investor tastes have shifted from the megacap tech names that have come to dominate benchmark indexes.

The Treasury curve steepened on bets the Federal Reserve is close to cutting rates. Former New York Fed President William Dudley called for lower borrowing costs — preferably at next week’s gathering. For many analysts, such a move would be worrisome as it would indicate officials rushing to avoid a recession.

The loonie fell as the Bank of Canada cut rates, focused on “downside risks.” The yen hit the highest since May amid an unwind in carry trades.

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To Steve Clayton at Hargreaves Lansdown, this could be the year markets start talking about the “So-So Seven,” noting that results from Tesla and Alphabet are not enough to maintain their momentum.

“The market is not impressed with the start of earnings season for the mega tech stocks,” said Kathleen Brooks, research director at XTB. “There was a lot resting on these results and we don’t think that they give clear answers to questions about the effectiveness and profit potential for AI right now.”

After driving the rally in stocks for most of 2024, big tech slammed into a wall. Traders rotated from megacaps to lagging parts of the market, spurred by bets on Fed rate cuts and concern AI still needs to pay off.

“Tech’s problem isn’t just that earnings are less than perfect, but the group is still caught up in the violent rotation trade that kicked off with the June CPI,” said Vital Knowledge’s Adam Crisafulli. “Many assumed the anti-tech rotation would be ephemeral and the fact it’s proving durable is compounding anxiety toward the group and spurring additional selling pressure.”

The drubbing in these stocks has seen some of the air come out of valuations. While that’s something that could argue in favor of dip buying, the earnings season is just getting started. Apple Inc., Microsoft Corp., Amazon.com Inc. and Meta Platforms Inc. are all due to report results next week.

To Jose Torres at Interactive Brokers, the equity correction is far from over.

Despite recent selling, the S&P 500 is still trading close to 22 times earnings amidst quarterly results that aren’t impressing investors in aggregate. In addition, the benchmark is still up about 15% year to date, which is terrific considering it isn’t even August. 

“Yesterday we wrote that a 10% to 15% correction was in the cards this quarter, historically the worst period of the year,” Torres said. “This quarter, the valuation concerns are paired with front-loaded gains, irrational exuberance, a high bar for earnings estimates and a presidential election.”

But as far as quarterly results, the concern is not exclusively related to tech. Broadly, second-quarter earnings season is off to a weaker start than usual. 

Among S&P 500 companies that reported results, profits beat analyst estimates by the smallest margin since the end of 2022 — while sales surprises were the worst in at least two years, according to data compiled by Bloomberg.

“We are still looking for volatility to increase moving through the second half of 2024 – with the potential for a 10% to 15% correction in benchmarks like the S&P 500 and the Nasdaq 100,” said Dan Wantrobski at Janney Montgomery Scott. “Our work does not point to secular/structural downturn at this time, but rather a pause in the reflationary expansion cycle that began a few years ago.”

Just as earnings roll in, a key technical indicator in the US stock market sat close to historic extremes — a crucial gauge that has foretold past selloffs. 

Known as the “the 200-DMA” — an abbreviation of 200-day moving average — the gauge measures how the S&P 500 is performing against that longer-term measure. At one point last week, the benchmark was trading as much as 15% above it, according to data compiled by Bloomberg. 

Although that does not necessarily mean the market is about to tank, it is a warning sign for investors concerned about lofty tech valuations and concentration risk.

The recent slump in US stocks is flashing a warning to trend-following funds: sell US equities no matter which direction the market goes. 

Both the Nasdaq 100 and the S&P 500 benchmarks have breached thresholds that trigger a selling signal for commodity trading advisers, or CTAs, according to models at Goldman Sachs Group Inc.’s trading desk. 

If stocks keep falling, those rules-based traders could unwind $32.9 billion of global stocks with $7.9 billion flowing out of the US market, according to an analysis from the bank’s trading desk. Even if the market reverses its slide, CTAs are still poised to sell $902 million of US stocks.

Corporate Highlights:

• International Business Machines Corp. reported a jump in bookings for its artificial intelligence business as customers work to implement the latest technology.
• Ford Motor Co. posted second-quarter profit that fell short of Wall Street estimates, saying quality problems with new vehicles led to a surge in warranty costs.
• Whirlpool Corp., the owner of Maytag, lowered its full-year earnings forecast, as consumers continued to shy away from big-ticket appliance purchases amid a weakening housing market.
• Chipotle Mexican Grill Inc. reported second-quarter sales that beat estimates as limited-time offers and speedy service helped to keep diner traffic high.
• ServiceNow Inc. reported better-than-expected sales and bookings, suggesting customer enthusiasm for the software company’s expanding suite of tools.

Key events this week:

• Germany IFO business climate, Thursday
• US GDP, initial jobless claims, durable goods, Thursday
• US personal income, PCE, consumer sentiment, Friday

Some of the main moves in markets:

Stocks

• The S&P 500 fell 2.3% as of 4 p.m. New York time
• The Nasdaq 100 fell 3.7%
• The Dow Jones Industrial Average fell 1.25%
• The MSCI World Index fell 1.8%
• Bloomberg Magnificent 7 Total Return Index fell 5.9%
• The Russell 2000 Index fell 2.1%

Currencies

• The Bloomberg Dollar Spot Index was little changed
• The euro fell 0.1% to $1.0839
• The British pound was little changed at $1.2905
• The Japanese yen rose 1% to 153.98 per dollar

Cryptocurrencies

• Bitcoin rose 0.1% to $65,934.43
• Ether fell 3.2% to $3,372.06

Bonds

• The yield on 10-year Treasuries advanced three basis points to 4.28%
• Germany’s 10-year yield was little changed at 2.44%
• Britain’s 10-year yield advanced three basis points to 4.16%

Commodities

• West Texas Intermediate crude rose 0.6% to $77.45 a barrel
• Spot gold fell 0.5% to $2,398.57 an ounce

This story was produced with the assistance of Bloomberg Automation.

–With assistance from Lu Wang, Jessica Menton, Felice Maranz, Sagarika Jaisinghani, Joel Leon, Natalia Kniazhevich, Tatiana Darie, Alex Nicholson, Julien Ponthus and Aya Wagatsuma.

©2024 Bloomberg L.P.