Global financial markets have been thrown into a tailspin as investors bet on an AI slowdown after the US midterm elections.
This is not the first time stock markets have wobbled in recent months due to concerns over a tech bubble. But could this volatility be the start of a huge market meltdown?
What has happened?
Shares on Wall Street plunged on Thursday, in a rout driven by AI and technology stocks that extended to Asia and Europe on Friday. US markets rebounded after trading reopened in New York, but failed to recover all of the lost ground amid lingering concerns of a relapse in selling pressure.
More than $3.2tn (£2.4tn) was wiped from the value of the US stock market on Thursday – bigger than the annual output of the Canadian economy – after the tech-heavy Nasdaq fell by 5.5% and the blue-chip S&P 500 fell by 4.4%.
After months of warnings over the valuations of AI companies – amid fears of tinderbox conditions in the world economy fuelled by the Iran war and concerns that the tech bubble could burst – the trigger for the sell-off has been attributed to the Democrats’ sweeping US midterm election victory.
Why did the midterms trigger a sell-off?
Investors are predicting that a Democrat-controlled Congress could lead to tighter control of AI and datacentre construction – slowing development in one of the engines of global economic growth and corporate earnings on the stock market.
Challenging billionaire power and calling out Wall Street and big tech were the rallying cries of many Democrats in the midterm elections. Moratoriums on datacentre construction were effectively on the ballot in several states amid growing public opposition to the building of vast, resource-hungry facilities.
Highlighting the stakes, the SpaceX and Tesla CEO, Elon Musk, set a record for election spending after pouring nearly half a billion dollars into backing Republicans – and moved his personal residence to Texas, the leading state for datacentre construction. After the midterms shares in both his companies fell sharply.
Weren’t there already concerns about an AI bubble?
Fears of an AI bubble have been growing for some time, given the astronomical rise in tech company valuations, which some analysts said had become increasingly detached from reality.
One measure of whether a market is overvalued, the cyclically adjusted price-to-earnings (Cape) ratio, had risen to its highest level since 2000, showing that the US stock market was unusually highly valued relative to profits.
Highlighting the disconnect, shares in Alphabet, the Google parent company, plunged last week after it reported lower than expected profits, wiping more than $500bn from its value.
Some form of a check on progress was also likely, amid a groundswell of public opposition to datacentre construction and worries over AI safety. Opinion polls show most Americans are opposed to US datacentre construction, while governments around the world have encouraged citizens to stockpile for multiple eventualities including cyber-attacks.
Ben Barringer, the head of technology research at Quilter Cheviot, said: “It is too easy to say that the Democrats will be bad for datacentres.
“Yes, there will be a pause in the buildout and delay in approvals, but if you go off the words of the new Texas governor-elect, Gina Hinojosa, they are likely to be more pragmatic and ensure resources are more fairly allocated.”
What does it mean for households?
What happens to the share prices of the US tech giants has enormous consequences for savers worldwide.
The “magnificent seven” tech stocks – Nvidia, Apple, Google, Microsoft, Meta, Amazon and Tesla – account for more than a third of the S&P 500, meaning that funds that track this index are directly tied to their performance.
AI has been a big growth driver, with the tech boom helping to soften the hit to the world economy from the war in the Middle East.
The prospect of a sustained tech sell-off could prove a big setback, in a blow to countries that have pinned their hopes on the AI revolution creating jobs and generating a productivity boost to overcome years of relative economic stagnation.
In response to the inflation shock from the Iran war, central banks around the world have been raising interest rates. However, an economic slowdown could force a rethink amid the risk of stagflation, when weak growth is accompanied by fast-rising consumer prices.
What happens next?
Financial markets are prone to volatile swings and investors are divided about whether things will get worse from here. Many were, however, worried a big crash was overdue – and when investors begin to lose confidence, it can become self-reinforcing.
Barringer said: “A virtuous circle could quickly turn into a vicious one, and they [investors] must now ride it out until the direction of travel becomes clearer.”
For some, the latest tech rout represents a reset rather than a lasting downturn. Demand for AI and semiconductors will not vanish overnight: new tools will continue to be launched, and datacentres will be built.
Mark Haefele, the chief investment officer at UBS Global Wealth Management, said the AI investment cycle should remain intact, despite the latest “market indigestion”.
“We do not think fundamentals justify a prolonged downturn,” he added.
