Market update: recovery takes hold, but investors remain on edge

After Thursday’s rout, another recovery is on the  cards for markets today. We mentioned earlier that the mini recovery in Bitcoin was likely to boost overall sentiment, as the link between crypto and AI stocks and the tech sector remains strong. Bitcoin is now higher by $5000 on the day, although it remains below the $70,000 level, silver and gold are recovering, and the S&P 500 is higher by more than 1%, led by the tech sector.

There are still pockets of weakness, Amazon is lower by 9% on the back of its earnings report on Thursday night, and its massive capex pledge. Also, if the repricing of crypto is the key support for AI-linked stocks, then the foundations of the recovery remain weak.

There are still reasons to be skeptical about AI. Tech earnings are strong so far, out of the 35 technology companies listed on the S&P 500, they have reported sales growth of 16% on average, and earnings growth of 24%. These are stunning results, however, most of this growth is not down to AI investments. For example, Meta and Google are still generating the bulk of their profits from their advertising businesses rather than their AI units.

This can be measured by return on invested capital, which is a measure of how tech giants are turning the billions that they have invested into AI into profits. The picture is not pretty so far. Bloomberg reports that the biggest AI spenders in the Magnificent 7 have seen their ROIC measures turn  lower this year, as they pour more money into AI investments before getting a strong return.

Tech enthusiasts will say that this is typical of growth stocks, which tend to favour investment and innovation above profitability, hoping that it pays off in the end. However, investors are looking for more solid fundamentals.

This is why the Magnificent 7 has seen a change in leadership over the last month. Apple, previously shunned because it did not have enough exposure to AI, is now leading the Mag 7, along with Nvidia, who will benefit from the hypersalers’ capex spending plans. Apple is higher by nearly 10% this week and is higher by another 1.2% on Friday.

Chart 1: Magnificent 7 over the past month, Apple is leading the way

Source: XTB and Bloomberg

The question as we move towards a new week is whether or not investors will continue to focus on AI investments and their return. If this is a structural issue, then we could see the AI hyperscalers and AI-linked stocks continue to struggle.

The selloff in silver over the last week is a clear sign that the market is getting nervous about bubbles. Interestingly, there is a shift in the precious metals space, gold is outperforming silver, and the gold/ silver ratio is turning higher at the fastest pace since the end of March last year. This suggests that gold is seen as a safer harbor in the storm compared to silver, and its relatively stable volatility compared to silver is also worth noting. The silver price is down 10% so far this week, while the gold price has clawed back all losses and is up more than 1%.

Chart 2: gold and silver ratio

Source: XTB and Bloomberg

The market is focused on valuations right now, as geopolitical risks are downgraded. Iran and the US have had a successful start to talks, and oil prices are close to session lows.

Overall, the selling pressure is easing for risky assets like tech stocks and bitcoin as we end the week. Next week brings its own set of risks including the delayed release of the January payrolls report.