These 2 Major Issues Will Determine the Market's Direction
As investors await the government reopening, a couple of important concerns will continue to influence stock performance.
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The House of Representatives is set to vote on the reopening of the government at 4 p.m. ET on Wednesday. Investors are anticipating a positive outcome, which is helping boost indexes in premarket trading.
The market had an unusually chaotic session on Tuesday as growth and AI names struggled while biotechnology and the DJIA sprinted higher. This was not typical rotational action, and it illustrates how investors are looking for shifts in market leadership and themes.
Two significant issues will drive the market action in the months ahead. The first is growing concerns about valuation in the AI sector. There is increased speculation about whether the massive spending on AI infrastructure will deliver the returns needed to justify current valuations.
According to a JPMorgan Chase (JPM) study, AI will need to generate $650 billion in profits to achieve just a 10% return on current AI investments. That is about 0.6% of global GDP. Those are hefty numbers, but if AI is as powerful as its promise, it isn’t outrageous.
The debate over AI valuation is unlikely to end soon, which means there will likely be elevated volatility in the sector. The strong, steady uptrend that helped drive the market over the last few years won’t be as strong or steady in the future. Rallies will be met with some skepticism, but pullbacks will be greeted by optimistic bulls.
On Tuesday, the skepticism about AI valuations hit the data-center group. CoreWeave (CRWV) was the primary victim, but the incident spilled over to the entire group. It will be informative to see how much interest there is in buying this pullback as the news is digested.
Also on Tuesday, biotechnology stocks (IBB) surged on news of a leadership change at the FDA. The FDA has been extremely chaotic recently, with uncertainty about its drug approval policies. The group was finally starting to see outperformance after lagging for years and may now be back on track if investor confidence in the FDA increases. I’m heavily long this sector.
The second issue that the market will be dealing with over the next few weeks is the likelihood of a Fed interest-rate cut at its next meeting on December 10. Currently, the odds of a quarter-point cut are just 65%, down from over 90% a month ago.
While there is increased concern about the strength of the jobs market, there is also increased worry about inflationary pressures. Prices are staying sticky, and inflation is still inching slightly higher. There will be several Fed members speaking on Wednesday, and the market will start to look ahead to the release of economic data once the government is reopened.
We have positive action early Wednesday, but the two significant issues of AI valuation and Fed dovishness will likely keep things choppy.
At the time of publication, Rev Shark had no positions in any securities mentioned.
