Finding Value in the Wreckage Following an AI Drubbing
Amazon’s weaker earnings and rising capex rattled investors. Despite early lift Friday in Nvidia and Bitcoin, there are reasons to be cautious.
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The recent market gloom is showing signs of lifting early on Friday morning despite a disappointing earnings report from Amazon (AMZN) . Although the S&P 500 has failed to reflect it, there has been some of the deepest corrective action in momentum and growth stocks in years.
Bitcoin and cryptocurrencies have been in freefall, precious metals have been wildly volatile, the Magnificent Seven stocks were consistently sold on good earnings, and the software sector was a dumpster fire.
The AI Capex Crisis
The primary catalyst for this horrendous action has been a reevaluation of AI. The entire group and everything tied to it have run on strong momentum for several years. Valuations were aggressive but were accepted until questions started to build about whether there would be sufficient return on the massive AI spending that was taking place.
Skepticism about capex spending began to build in October after a massive Oracle (ORCL) data-center deal. Then, recently, Microsoft's (MSFT) earnings report raised concerns about how AI technology was not helping to boost software profitability. A wave of selling hit software, and names such as Palantir (PLTR) could no longer demand a sky-high valuation despite exceptional growth.
Spreading Growth Concerns
This week, the market selloff in AI accelerated on concerns about continued high levels of capital spending. Google (GOOGL) recovered fairly well, but its increased spending worried investors, even though the company is seeing a good return on investment. Even stocks like Nvidia (NVDA) and data-center names that should benefit from higher levels of capital spending were sold because of general concerns about AI and software.
The selling in AI quickly spread to other high P/E growth names. Even stocks with high levels of growth that were not that expensive were sold along with everything else. The most difficult aspect of corrective action like this is that it is driven from the top down and punishes every stock in certain indexes or sectors.
Finding Value in the Wreckage
Everything is sold in panic action like this, but then eventually the value buyers will start sifting through the wreckage and find the good names that were unfairly punished. There are signs Friday morning that buyers are starting to nibble at some of the hardest hit names. Bitcoin is finally bouncing, and Nvidia is trading up.
The Amazon Anomaly
The Amazon earnings report is a problem, but it does not appear to be impacting the many stocks that have already been poorly punished. When Google reported on Wednesday night, analysts across the board raised their price targets. Amazon is seeing a very different response and analysts are cutting price targets. Amazon is raising capital spending like Google, but it is not showing the same level of return on its investment.
My Game Plan
A bounce following deep corrective action will provide some relief, but there are reasons to be cautious. There are many trapped investors who would love to reduce exposure in names that have recently caused them great pain. Oversold bounces are hard to trust because they quickly run into technical overhead.
The good news is that a bounce does create a key level of support. There will now be a clear low on the charts, and as long as that holds, a foundation for more upside can be built.
At the time of publication, Rev Shark was long GOOGL, NVDA and AMZN.
