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On Semiconductors, Neoclouds & Threats To Undersea Cables
Investors rewarded semiconductor maker AMD’s impressive Q3 earnings report, which reflected robust compute demand and expanding market share. Yet the S&P 500 Semiconductor industry at large has been out of investor favor for a number of possible reasons. … Also: Neoclouds may have a tougher time pursuing their data center aspirations, Jackie reports, given tighter credit conditions and now the midterm elections’ Blue Wave. Democratic leaders are much more likely to impose hurdles to slow the data center buildout. … And: Geopolitical strife has three nations threatening or preparing to cut the undersea Internet cables on which modern life as we know it depends.
Gridlock Won & Markets Cheer
I. Why Wall Street Is Cheering the Blue Sweep Ahead of Tuesday's midterm elections, we warned that a Democratic sweep of Congress could deliver a cold shower to Wall Street. It still could, but it didn't do so today. Democrats captured both chambers of Congress, flipping seven Republican-held Senate seats, including historic victories in Texas, Kansas, and South Carolina. Financial markets put a positive spin on the blue wave. Oil prices fell on hopes that the US and Iran are more likely now to resolve their war diplomatically. If so, then the outlook for inflation will improve. So the Fed might not have to raise the federal funds rate as much. The federal deficit might not widen further if Democrats refuse to increase defense spending, while President Donald Trump vetoes their attempts to provide Medicare for all. If Democrats slow the AI buildout, hyperscalers' profits and free cash flow will increase. Fewer AI-related bond issues would also help keep a lid on bond yields. Initially, Nasdaq-100 futures plunged as much as 2.4% overnight, while S&P 500 futures fell 1.4%. But the selloff reversed after Trump struck a surprisingly conciliatory tone, congratulating Democrats and saying he was willing to work with them. That is when the cheer on Wall Street started. The Dow surged 3.0% today, the strongest post-midterm rally since 1982. The S&P 500 jumped 1.6%, its best session in three months. The Nasdaq-100 advanced 0.9%. The relief rally extended beyond equities. The 10-year Treasury yield fell to 4.90%, back in what we have called the "old normal" range of 4.00%-5.00% (chart). The dollar index (DXY) fell more than 1.5%, its biggest decline since September. Gold rallied back above $4,000 an ounce. It might be finally bottoming. Brent crude plunged 8.7% to $94.62 a barrel amid hopes of Middle East de-escalation. The nearby futures price of gasoline plunged to $2.73 (chart). Investors may be warming up to the idea that some constraints on the AI buildout could be healthy, as we have been arguing recently. Democratic victories in key data center states, including Texas and Georgia, raise the prospect of tighter construction restrictions amid concerns about electricity and water consumption. Hyperscalers rallied today, with Amazon and Microsoft gaining more than 6%, as capital discipline could ease concerns about AI investment returns and improve free cash flow (chart). AI infrastructure providers struggled, however. The PHLX Semiconductor Index fell 3.1% amid fears of weaker demand from a slower buildout. We may be entering an AI Goldilocks zone, with enough restraint to take some air out of the bubble without derailing the boom. II. The US Economy Continues To Perform Well The economy and, therefore, earnings remain fundamentally resilient, which continues to support the bull market. With the midterms behind us and political uncertainty receding, investors can refocus on these strong fundamentals. Here are the highlights of today's upbeat economic indicators: (1) ISM Services PMI. The ISM-NM PMI edged down modestly to 54.5 in October, marking its 28th consecutive month of expansion (chart). Underlying demand remained solid, with new orders and business activity both comfortably above the 50.0 expansion threshold. Encouragingly, the employment index rose from 50.1 to 51.4, marking its second consecutive month of expansion. Inflation is still a concern. The ISM prices-paid indexes remained elevated in October (chart). (2) Labor market. The average of the ISM employment indexes rose to 51.9 in October, its highest reading in roughly three years (chart). ADP reported an 86,000 increase in private payrolls in October, beating consensus expectations of 67,000. (3) Trade balance. The latest trade data point to resilient US and global economic growth. Merchandise imports rose 2.4% m/m in September to a record $3.44 trillion annualized, while exports increased 2.5% m/m to $2.09 trillion. The merchandise trade deficit widened to $1.35 trillion annualized (chart). Nominal and real US merchandise exports plus imports rose 21.1% y/y and 10.1%, respectively, in September (chart). That suggests global trade remains firmly in expansion territory and is consistent with strong global economic growth. Selected technology imports reached a record $61.3 billion in September, reflecting the AI buildout’s heavy reliance on imported semiconductors, servers, and other hardware (chart).
On BOE Decision, Q3 Earnings & Bubble Meter
The Bank of England is walking a tightrope, William explains. The central bank needs to raise its key interest rate this week to rein in inflation and preserve credibility but also needs to temper investors’ aggressive expectations of rate-hiking to come. Pushing rates much higher could reignite gilt market stress and complicate the new PM’s efforts to establish fiscal credibility. The rate move would telegraph three messages about central bank decision-making in the global economic environment. … Also, Joe shares insights from the earnings results of the S&P 500’s September-quarter reporters to date. … And Melissa introduces the new and improved Bubble Meter that she and Claude have built.
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