Nasdaq 100 Fell By Over 3% and Lost a Trillion Dollars In Worst Trading Day Since 2022

On Wednesday, the Nasdaq 100 Index suffered its most significant drop since October 2022, plummeting over 3% and wiping out $1 trillion in value. The market's infatuation with artificial intelligence (AI) technology faced a harsh reality check, raising concerns about the time it will take for hefty investments in AI to yield returns. Let's delve into the reasons behind this downturn and what it means for your investment strategy.

Is The AI Bubble About to Burst?

Investors have been pouring money into AI, anticipating rapid returns. However, a middling earnings report from Alphabet Inc. triggered a selloff. Alphabet's report revealed substantial capital expenses, causing its stock to fall over 5%, its worst performance since January. Tesla Inc. also took a hit, plunging more than 12% after CEO Elon Musk provided little insight into the company’s self-driving vehicle plans.

Alec Young, Chief Investment Strategist at Mapsignals, remarked, “The overarching concern is, where is the ROI on all the AI infrastructure spending? There’s a pretty insane amount of money being spent. Maybe it’ll pay off in a few years. But I think investors realize that the payoff is going to take time to materialize and the hyper scalers earnings are being hurt in the short term by how much they’re spending on it.”

Market Volatility and Rotations

The tech sector faced increased volatility. Options volatility on Nvidia reached its highest level since mid-March, while the premium for puts on Broadcom Inc. hit a three-month high. These movements indicate traders are paying more to protect against swings in tech stocks.

Two weeks ago, a cooler-than-expected inflation reading sparked a massive rotation from tech winners to companies poised to benefit from potential Federal Reserve rate cuts, primarily small-cap stocks. For the fourth consecutive session, small caps outperformed larger stocks, with the Russell 2000 rising 0.5% this week, compared to a 1.5% loss in the S&P 500 and a 2.6% drop in the Nasdaq 100.

Tech Stocks’ Violent Selloff

The selloff was violent, suggesting deeper issues. Some Wall Street voices suggest the AI rally might be a bubble that added $9 trillion in value to the S&P 500 over the past year. This drop might not mark the bubble's burst, but it raises alarms. Neville Javeri, Portfolio Manager at Allspring Global Investments, stated, “In the short run, there may be a little AI fatigue, just because some of these investments that the Big Tech companies have made in AI may not be paying off in the time period that investors had in mind.”

Hardware makers for AI computing, which had seen significant gains this year, faced the largest drops during the Nasdaq 100 plummet. Super Micro Computer Inc. fell 9.15%, Nvidia lost 6.8%, and Broadcom Inc. dropped 7.6%. Major tech companies also retreated, with Meta Platforms Inc. down 5.6%, Microsoft Corp. sliding 3.6%, and Apple Inc. falling 2.9%.

Nasdaq 100’s Short-Term vs. Long-Term Perspectives

Some traders view the selloff as temporary. Michael Sansoterra, Chief Investment Officer at Silvant Capital Management, commented, “I don’t think you’re seeing anything other than some stocks that have done exceptionally well, have very solid year-to-date returns, seeing some profit-taking in the face of not getting a giant beat and raise out of Google.”

However, Jim Covello, Head of Equity Research at Goldman Sachs Group Inc., warns that AI’s commercial potential might be overblown. The vast expenses to build AI infrastructure are daunting. Derivatives markets, where bullish options on Nvidia and other tech stocks fueled the rally, have seen sentiment shift, potentially adding to Wednesday’s downturn.

Tech Stock Valuation Concerns

Tech stock valuations had entered frothy territory. The S&P 500 information technology index’s price-to-estimated earnings ratio recently hit its highest since 2002. Big Tech stocks, despite the selloff, remain highly priced. Nvidia trades at 36 times projected profits for the next 12 months, compared to the S&P 500’s average of 21. Apple and Microsoft are priced at over 30 times earnings. This raises the stakes for earnings at a challenging time, with profit growth for tech giants set to slow.

Despite Alphabet’s underwhelming results, the market still hopes for positive reports from other Nasdaq 100 major players. Microsoft Corp. will report on July 30, followed by Meta Platforms Inc., Apple Inc., and Amazon.com Inc. Nvidia, the largest beneficiary of AI spending, reports on August 28.

Cayla Seder, Macro Multi-Asset Strategist at State Street, maintains a positive outlook on tech, saying, “We are still holding onto our large-cap, quality, growth view. Because even if there is trepidation around tech earnings, they are a more attractive option in terms of earnings growth and fundamental strength.”

Wake Up and Smell the New AI Reality

Wednesday’s Nasdaq 100 plunge serves as a wake-up call for investors. While the long-term potential of AI remains promising, the short-term volatility and high valuations warrant caution. As always, maintaining a balanced, diversified portfolio is key to navigating these uncertain times.

Do you have significant investments in Nasdaq 100 stocks? Were you able to minimize your losses today? Share with us your observations.