Over the past few months, the stock market has been dominated by two narratives: (1) the long-term viability of AI trade, and (2) the impact of the Iran war.
The story rotates as the days pass. Multibillion-dollar AI infrastructure collaborations could one day make tech stocks rich. The same group could rebound the next day on data showing inflation is cooling.
They also played a role in protecting each other. If major chip makers release disappointing sales forecasts, it could be offset by easing tensions between the U.S. and Iran.
Simply put, there is usually something that excites investors, or at least assuages negative emotions. And that’s helped keep the major indexes within striking distance of all-time highs, albeit with some fluctuations along the way.
On Thursday, that volatility showed its anger in a different way. That’s because the selloff was a byproduct of both headwinds blowing at the same time.
The S&P 500 fell 1.2%, and the tech-heavy Nasdaq 100 ended down nearly 2%. The damage was even worse in areas adjacent to AIs like Magnificent 7, which suffered 4% damage overall.
Ultimately, this episode resulted in two of the market’s most important catalysts combining to form a major downward arrow in stock prices. In many ways, this situation represents a kind of worst-case scenario for stocks. Let’s unzip both parts.
1. Oil prices rise again due to Iran war
what happened: After a welcome period of falling below pre-war levels, oil prices have once again climbed above $100 as the conflict between the United States and Iran flares up. This raised inflation expectations. Investors are keeping a close eye on this as they see the impact of the prolonged closure of the Strait of Hormuz reflected in CPI data.
Rising inflation expectations are prompting investors to accelerate expectations for interest rate hikes, which have traditionally been bad for stocks. This sequence of events helps explain Thursday’s bad day for the market.
What’s next: As always, the ball is in the court of the Trump administration and its Iranian negotiators. Markets are eager for a peace agreement and have shown that they are willing to price it in. What the market needs is some sign of progress, and there’s been little of that lately.
2. AI Trade Investors Decide They’re Tired of All the Expenses
what happened: On Thursday, Alphabet and Tesla were the latest tech companies to learn that impatient traders are tired of spending on capital and want tangible results instead. Chipmakers including TSMC discovered this at the beginning of this earnings season, and now it looks like a warning of what’s to come.
Alphabet fell 7% after raising its spending forecast, offsetting strong revenue and strong growth from Google’s AI-focused cloud business. Meanwhile, Tesla fell 15% after promising more spending and Profit estimates are missing.
What’s next: The remaining major Magnificent 7 hyperscalers (Meta, Microsoft, Amazon) will report earnings next week. At this point, it doesn’t matter what numbers companies report, whether they increase capital spending or not. We could also see another round of AI stock declines as companies unashamedly embrace adoption.