Wentz Weekly: AI Driven Rally Takes A Pause

Wentz Weekly Insights
Stocks Lower As AI Rally Takes A Pause

After three straight weekly gains, stocks moved lower last week in what was broad based with the riskiest of assets down the most. The tech sector was down over 4% driven by declines in most of the Magnificent 7 names; Nvidia, Microsoft, Apple, Amazon, Alphabet, Meta, and Tesla. The tech-heavy Nasdaq index was down 3.04% while value stocks held up better with the more value-oriented Dow index down 1.21%. The S&P 500 fell 1.63% while the equally weighted S&P 500 was down just 0.20%.

There wasn’t one single piece that moved markets last week but a list of items. Regarding tech, the theme seemed to be more scrutiny in artificial intelligence when it comes to valuations, the amount of investments being made, and questions on return on investment. OpenAI, creator of ChatGPT and considered a leader in AI, received more attention from its $38 billion deal with Amazon which made its recent commitments around $1.5 trillion (yes trillion).

This brings the “circularity” dynamic to the top of mind – a situation where companies use their cash to support start ups and other companies, who in turn use the funds to procure AI chips (for example, Nvidia invests in OpenAI and OpenAI turns around and uses the capital to purchase Nvidia chips). In this case, there is no new real revenue, it creates a “circular ecosystem” of capital flow concentrated among a few companies.

As we mentioned in recent weeks, the announced investment in AI in remarkable, particularly from the top companies. Most of the investment goes into the advanced chips from Nvidia and the data centers that house the chips/racks.

The top tech companies alone (Amazon, Microsoft, Google, Meta, and Oracle) have committed $391 billion in capital expenditure for this year, up from $253 billion, or a 55% increase, from last year. In addition it is expected the spending will increase to nearly $500 billion next year. The AI spending is spilling over into credit markets now too with some companies issuing debt to fund their infrastructure investments. For example, Oracle, Meta, and Alphabet recently raised $18 billion, $30 billion, and $17.5 billion respectively, through bond sales.

Another big theme was earnings reports. The bulk of Q3 earnings reports are behind us with about 90% of the S&P 500 having reported quarterly results as of Friday. The results have been better than expected overall – of the companies that have reported, 82% have seen better earnings than expected and 77% have seen better revenue than expected, both above the 10-year average beat rate. The earnings growth rate is at 13.1%, well above the 7.9% that was expected by analysts when the quarter ended.

One thing we noticed was companies that have beat earnings are being rewarded less with share prices gains lower than what we have historically seen while companies that miss earnings are being punished more with larger declines than normal. This may be due to the fact expectations and valuations are already high.

The government shutdown has added to the uncertainty and volatility in markets. While we have seen very little economic data, some private market data reports continue to suggest a slowing economy. For example, the Challenger Job Cuts report, a monthly report that measures corporate layoffs and something that typically doesn’t receive as much attention, showed there were 153,000 job cuts in October, triple the amount from last month and the most in an October in over 20 years.

The shutdown is now over 40 days and the longest ever and each day that passes will have a bigger impact. The impact is being felt by federal employees who have missed three paychecks and now being felt by many that have travel plans with the Federal Aviation Administration cancelling 10% of flights to ensure safety due to the lack of air traffic controllers. There was slight progress over the weekend after the Senate advanced a bill in a 60-40 vote after getting some support from moderate Democrats.

Still though, key differences remain in the House and as of Monday morning there was no plans to schedule a final passage vote to send to the House.

The other story on the political side relates to tariffs with the Supreme Court hearing oral arguments on President Trump’s use of emergency powers to implement tariffs. Early remarks by Supreme Court justices reveal they are skeptical of Trump’s legality around imposing the tariffs and overturning this could mean the US is forced to refund collected tariffs. If this is the case we would expect the biggest impact in bond/Treasury markets, with pressure on Treasuries (higher debt) that would put upward pressure on yields.

The list of uncertainties is adding up and we believe will lead to more volatility as we head into what is historically the strongest part of the year (November and December). This week is expected to be slower with only about 10 S&P 500 companies reporting earnings and a lack of economic data due to the shutdown (inflation data is scheduled but likely to be delayed again).

Recent Economic Data

• Employment Situation: Delayed
• Job Openings and Labor Turnover Survey: Delayed
• Jobless Claims: Delayed
• Productivity & Costs: Delayed
• Factory Orders: Delayed
• Construction Spending: Delayed
• Trade Balance: Delayed

• ADP Payrolls: ADP said it saw 42,000 new payrolls in October, slightly above expectations and comes after a 29,000 decline in payrolls from the month prior. However it was very mixed, jobs in professional services, information, and leisure and hospitality saw declines, while growth was seen in education/healthcare, trade, and transportation.

• Challenger Job Cuts: Not a report that is typically followed closely but making more headlines last week – the Challenger Job Cuts report (monthly report on corporate layoffs based on data from state labor departments) showed job cuts increased to 153,000 in October, almost triple the amount from the month prior and the highest October total in over 20 years. The year-to-date total is about 1.1 million, a 65% increase from the same period last year and the highest since the pandemic.

• PMI Manufacturing Index: The PMI Manufacturing index was 52.5 for October, slightly more than expected and a slight improvement from September, indicating manufacturing conditions have expanded at a modest pace in the month. The report noted higher production which stemmed from the fastest demand growth in 20 months, however tariffs are continuing to weigh on exports, which declined (all the growth came domestically), and resulted in another “steep rise” in input prices.

• ISM Manufacturing Index: The ISM Manufacturing index was 48.7 for October, dropping from 49.1 in September which indicates declining manufacturing conditions for the eighth consecutive month. The report noted a contraction in production and inventories led to a decline in the index, reflecting economic uncertainty. The employment index remained negative while the prices index moved lower but remains elevated. Only 6 of the 18 sectors reported growth in the month while the other 12 reported contraction.

• ISM Services Index: The ISM services index rose to an eight month high of 52.4 in October, improving from a breakeven level of 50.0 in September, indicating services activity picked up in the month. New orders at 56.2 were the best since last October. Employment remains weak at 48.2, but did show a slight improvement from 47.2 last month, however, has been in contraction (below 50) since May. On the other hand, prices expanded at a faster pace, in fact prices increased the most since October 2022, with the index for prices at 70.0.

Company News

• Microsoft: Microsoft CEO said the company is no longer constrained by lack of supply of AI chips but is not constrained by availability of electrical power and data center space. Separately, Microsoft made a $9.7 billion deal for AI cloud capacity from IREN while IREN will purchase $5.8 billion of GPUs/AI chips and equipment from Dell. Microsoft also pledged to spend $7.9 billion on data centers in UAE through 2029.

• Kenvue: Kimberly-Clark announced it has agreed to acquire Kenvue, maker of over-the-counter drugs like Tylenol and other products like Band-Aid and Listerine, for nearly $40 billion, in a cash and stock deal. Kenvue shareholders will receive $3.50 in cash and 0.14625 shares of Kimberly-Clark for each share of Kenvue owned, which values the deal at $21.01 per share, about a 46% premium to where shares traded prior to the announcement. The company expects about $1.9 billion in cost synergies and $500 million in incremental profits from revenue synergies within three years of closing.

• OpenAI: OpenAI and Amazon agreed to a $38 billion multi-year deal where Amazon’s cloud division, Amazon Web Services, will provide its infrastructure to OpenAI’s workloads, giving OpenAI access to its hundreds of thousands of Nvidia advanced GPUs (graphic processing units) that power artificial intelligence. Until this year, OpenAI had an exclusive agreement with Microsoft, a partnership which first started in 2019, to provide access to its data centers, but the preferential status expired under its newly negotiated terms, giving OpenAI the ability to partner with more hyperscalers.

• Apple: Bloomberg reported Apple is near a deal to pay Google about $1 billion per year for an “ultrapowerful 1.2 trillion parameter” AI model developed by Google that would help run its overhaul of the Siri voice assistant. The report says Apple is banking on Google’s help and its leadership in AI to rebuild Siri’s technology, which will bring a new slate of features next year. Apple tested Google’s Gemini, OpenAI’s ChatGPT, and Anthropic’s Claude, but zeroed in on Google’s earlier this year. Apple views the partnership as temporary as it works on its own large-scale AI model.

• Disney: Penn Entertainment reported earnings and with it said it has agreed with Disney to terminate its sport betting agreement where Disney agreed to provide Penn with media, marketing services, and exclusive rights to ESPN Bet in exchange for cash. Penn said it will realign its focus on its iCasino business while Disney said it entered into a partnership with DraftKings where DraftKings will be exclusively integrated across ESPN with a full rollout coming in 2026.

• Nvidia: The Information is reporting the US government has told federal agencies it will not allow Nvidia to sell its newest, scaled down AI chip to China, a chip that Nvidia developed specifically for China. The report added Nvidia will work on modifying the chip’s design in hopes of receiving US export approval.

• Tesla: Tesla shareholders voted for Elon Musk’s new pay package, with 75% voting in favor, that included $1 trillion in compensation (almost all equity based). The package is broken into 12 tranches, and a full payout would happen if the company delivers on aggressive targets that lift Tesla’s market value (to $8.5 trillion by 2035) and build on its robotaxi and robotics business. Separately, Musk said Tesla may build a gigantic semiconductor fabrication plant (manufactures the chips) to support its growth in AI and robotics to ensure Tesla has access to the volume of chips it believes it needs.

• Ford: The Wall Street Journal reported Ford executives are actively discussing discontinuing the F-150 Lightning, its EV pickup truck, due to low demand and an end to the government tax credits. The EV has also been suffering from numerous recalls, software glitches, and reduced range during cold weather or when towing, all leading to a consistent loss on the vehicle for the company, which the report says has added up to $13 billion in losses since 2023.

Other News:

• China Trade: Reuters reported China issued guidance to companies building new data centers that are receiving state funds that it can only use locally made AI chips. This comes after recent reports that said China has ordered data centers that are less than 30% complete to remove all installed foreign AI chips and cancel all plans to buy them. Separately, China’s President Xi said China will suspend retaliatory tariffs it had in place on US goods but will keep in place the 10% tariffs it had imposed following Trump’s Liberation Day tariffs.

• Air Traffic Cuts: The FAA (Federal Aviation Administration) said it plans to reduce air traffic by about 10% across 40 high volume airports starting last Friday to ensure safety if the government shutdown has still not ended. The FAA is dealing with staffing shortages for air traffic controllers and has said about 13,000 air traffic controllers have been working without pay with a surge in workers calling in sick recently. CNBC said the 10% cut could affect 3,500-4,000 flights daily.

• Trump Tariffs Goes to Supreme Court: The Supreme Court began hearing arguments on Trump’s legal authority to impose tariffs using the International Emergency Economic Powers Act (IEEPA) and early reports say most Supreme Court justices appear skeptical about the legality of the tariffs. Critics say they infringe on the power of Congress to tax.

• Obesity Drug Pricing: Trump said during an announcement from the Oval Office that the government made deals with Eli Lilly and Novo Nordisk to cut the prices of their obesity drugs to expand access to the treatments. The deal will make the drugs available directly to consumers at a discount through a new website the administration will launch in January, TrumpRx.gov, and will make available and cut prices for Medicare and Medicaid beneficiaries. The administration noted the drugs would be available for $149/month.

Did You Know…?

Medicare Open Enrollment:

Medicare open enrollment period runs from October 15 to December 7 each year and during this period, individuals are able to make changes to their current Medicare coverage. Individuals on Medicare should receive an Annual Notice of Change and/or Evidence of Coverage for Medicare Advantage or Part D plan. This is a good time to review coverage, as medical needs, benefits, and premiums may have changed over the year. During this time here are some things to consider:

• Will your primary doctor still accept you Medicare Advantage Plan?
• Have your medical needs changed? Different plans offer different benefits and different costs
• Are there comparable, lower cost plans available? Don’t forget to consider out-of-pocket costs when comparing options
• Are you medications still on your plan’s list of covered medications?