Semiconductors fell 7% on the morning of May 19 from their all-time high the week prior. The huge run-up in chip prices, brought on by a surging order backlog for the massive build-out of hundreds of data centers, remains a rational move. However, the run-up in interest rates left them vulnerable to valuation concerns when viewed through the lens of the price-to-earnings (P/E) ratio using historical earnings. High-growth-rate stocks are highly vulnerable to increased discount rates when risk-free bond yields rise.
The AI narrative has been driving the market more than just theoretically. Essentially all of the upward earnings revisions for 2027 in the S&P have been for AI hardware and energy. All other sectors have been more or less awash. AI hardware has risen to 18% of the S&P. It has become a classic crowded trade.
Profit-taking is to be expected in these circumstances, given that stocks become extended when so many investors are holding at a profit.
But the sector is arguably cheap relative to projected earnings, which are more likely to rise than fall given the projected global shortage of compute. It would not be a surprise to see the sector recover to new highs after the current sell-off plays out.Â
The concerning rise in interest rates
While interest rates are obviously being driven by inflation triggered by higher energy prices (which will pull back once the Iran situation is resolved), the current rise is causing plenty of damage in government refinance rates and the housing market.
Higher rates, along with higher energy prices, also create demand destruction by prompting people to postpone spending as they wait for prices to come back down. We find the U.S. 2-year Treasury yield up 4bps, the 10-year +5bps, and the 30-year +3bps. All are at multi-year highs. International rates are following the U.S. higher.Â
Related: 5-star analyst drops eye-popping Intel stock price target
The tech sell-off continues, with the Magnificent 7 down 1.2% and now down 3.5% from last week’s all-time high, still up 4.1% for the trailing month.
This also hits consumer discretionary, which is dominated by Tesla (TSLA) and Amazon (AMZN).Â
Basic Materials are also weak, down 3.2% for the trailing month, as gold is down 6.4%, silver -7%, with copper +1.7% in the trailing month. Bitcoin is down 4.4% for the trailing week. Most of this damage comes from higher interest rates.Â
On a positive note, we aren’t seeing a widening of corporate bond credit spreads, reflecting a lack of concern about recession risks. We are primarily feeling the heat of energy-driven higher interest rates. If the economy were in poor shape, the damage would be much greater. The market sees the energy situation as transitory, not permanent.
The weakness in semiconductors will be addressed directly tomorrow when NVIDIA (NVDA) announces earnings. A bullish outlook, including a confirmation of the shortage of compute capacity for the foreseeable future, could turn the market around in a hurry.Â
Overall, the longer-term trend remains positive, the AI narrative remains intact, and no one wants to sell much in front of a resolution with Iran.Â
Related: Morgan Stanley resets Nvidia stock price target ahead of earnings