In yesterday’s note, we talked about the concern over “intra-industry” funding among the AI giants.

 

It's feeding fears of an AI bubble.

 

But as we discussed, it looks more like a feature of the AI infrastructure boom, not a bug.  By coordinating capital, compute capacity and AI deployment, the momentum in AI infrastructure development continues, and with that, the probability that America wins the race for global AI leadership increases.

 

And when the point of overbuilding/overspending is hit, the hyperscalers will dial back capex, which just means their free cash flow goes UP (which is already in the 10s of billions of dollars every quarter).  

 

They are already cash flow machines.  When AI adoption is widespread (and data centers are humming around the clock) they will generate even more cash.

 

More broadly, two-thirds of the S&P 500 have reported Q3 earnings, and the numbers are very good: 83% have beaten earnings estimates and 79% have beaten revenue estimates.  And earnings growth is tracking near 11%, which would be four consecutive quarters of double digit earnings growth.

 

So, earnings are good.  The economy is good.  The Fed is in an easing cycle.  All good for stocks.

 

That said, we spent some time last month talking about the setup for a technical correction in stocks.  And there were technical and fundamental reasons to believe Nvidia would lead it.  Nvidia did have a 10% correction over nine short days.  Broader stocks had a much shallower decline.

 

But we still have this chart from FactSet on valuation …

 

Last week (October 29th), the forward P/E on the S&P 500 was above 23.  As you can see, that's happened only one other time on this chart — on September 2, 2020. 

 

What happened on September 2, 2020?   

 

Stocks started a 10% correction on that day, for a duration of 15 days peak-to-trough.  And that correction came after the 65% rise from the March 2020 lows (the depths of the covid lockdown-induced crash in stocks).

 

The economy was bouncing back very strongly.  There was war rhetoric around China.  But this was a technical correction.

 

So, given this valuation data point, are we in the early stages of a technical correction for stocks right now? 

 

If we look at the October 30th high in the S&P 500, it did come with an outside day (a technical reversal signal).  Stocks are down 3% since.

 

As we discussed last month, the garden variety 10% corrections of the past two years have resulted in a Fed reaction (either signaling or direct policy action).  In the current case, that would mean the Fed restoring expectations of a December cut.