Phew, the rally is back on, as AI boom continues

European stock markets are a sea of green on Wednesday. Stocks are rising, US stocks are also pointing to a higher open, bond yields are falling, and the dollar has backed away from recent highs. The tech giants that wobbled on Tuesday also look set to rise on Wednesday, which suggests that fears about the end of the AI trade have been overdone.

Fears about AI profitability cast aside for now

Oracle, who said that margins in its cloud computing business would be smaller than expected and saw its stock price fall on Tuesday, is rising in the pre-market on Wednesday. This suggests that yesterday’s sell off in the tech sector was a blip, and for now, the AI trade has not been compromised by Oracle’s admission about its profit margins.

Nvidia’s Huang says demand remains exponential

Nvidia’s Jensen Huang could help to boost the mood for AI related stocks on Wednesday, even though the Bank of England’s Financial Policy Committee said that surging valuations of AI firms has increased the risk of a sharp market correction. Huang said that demand for AI computing prowess is huge so far this year, because AI models’ results have been so good. This, explained Huang in a TV interview, could lead to the next stage of the AI rally since we are at the beginning of a ‘new buildout, at the beginning of a new industrial revolution.’ The question for traders, will they listen to the BOE or the CEO of Nvidia, we think that we’re at the stage of the stock market rally where the CEO will win out.

Concerns about AI companies all investing in each other creating a fragile circular ecosystem, may also be put to bed for now. However, if we see another OpenAI/ AMD style deal announced in the coming days and weeks, it is worth watching how the market reacts. The AI trade could be in a bubble, but we don’t think it will end any time soon. The next stage of the AI trade could be more volatile, as results and financing deals garner more criticism.

Why the US government shutdown could fuel further gains for AI stocks  

If the AI trade does slow down later this year, then we could see opportunities for other sectors to play catch up. The equal weighted S&P 500 index has underperformed the market cap S&P 500 since the April low, as you can see below. The US economy is at an interesting junction: GDP is expanding at the same time as the labour market is slowing down. If the economy continues to make strong gains like it did in Q2, then we could see the labour market play catch up. If this happens then some of the biggest laggards on the S&P 500 like Lululemon, Deckers and Constellation Brands, could play catch up.

Of course, for this to happen we need to see the latest economic data releases. They have been delayed due to the ongoing government shutdown in the US, which shows no sign of ending. Until we get a better idea of the strength of the labour market, it will be hard for unloved sectors of the market like consumer stocks, to recover. This could also add fuel to the AI fire, since buying weaker sectors of the S&P 500 without any details about the strength of the US labour market is not prudent. Instead, the path of least resistance for the stock market remains the AI trade.

Chart 1: S&P 500 equal weighted, S&P 500 market cap weighted, and the Magnificent 7. The Mag 7 have led the market recovery since April, while the equal weighted S&P 500 has lagged behind.

Source: XTB and Bloomberg

France: can kicked down the road in French political crisis

Concerns about French politics have also eased on Wednesday and French bond yields are falling across the curve and French bonds are the top performers in Europe so far today. Outgoing PM Sebastian Lecornu has expressed optimism that he can form a new government, and that a budget can be passed through parliament by the end of this year. This comes after the centrists made a big concession to the Socialist left and agreed to shelve plans to lift the retirement age to 64 from 62. Lecornu also said that the budget deficit would fall to 5% next year, although it is unclear where savings will come from.

The stage is being set for a major showdown about the economic direction of France at the next Presidential election, in 2027. With that can potentially kicked down the road, European stocks and bonds can continue to rally.

Gold remains the ultimate hedge

Interestingly, with no long-term solution to the French fiscal crisis, and with warnings about the AI trade being in a bubble and a threat to financial market stability, the gold price is acting like the ultimate hedge, and it is maintaining gains above $4,040 per ounce as we progress through Wednesday.