NVIDIA can't save AI stocks, what does the market want to see?

Even NVIDIA, at the core of the artificial intelligence (AI) wave, has not been able to quell market anxiety despite its impressive performance.

Last week, after NVIDIA announced strong earnings, its stock price surged over 5% on Thursday, but then quickly reversed, closing down 3.2%. This rollercoaster market movement rapidly spread to the entire market, with the S&P 500 and Nasdaq 100 indices also peaking and then retreating, ultimately closing lower.

This dramatic reversal highlights that a strong earnings report is no longer sufficient to support the high valuations of AI concept stocks. Market doubts are spreading from NVIDIA to the entire AI ecosystem, including other semiconductor companies and tech giants like Microsoft and Meta, which have made significant investments and have recently faced immense pressure on their stock prices.

“We saw a brief relief rally following the earnings report confirming strong demand, but investors are now starting to ask the next questions: What about power demand? What about margins? What is the return on investment (ROI)?”

Natalie Hwang, managing partner at Apeira Capital Advisors, stated, “As long as there are unresolved questions in the market, relief rallies cannot be sustained.”

Chill Spreads: AI Ecosystem Under Pressure

Market concerns are spreading throughout the AI ecosystem. An index tracking chip-related stocks fell 11% in November, heading towards its worst month since 2022, with both AMD and Arm seeing declines of over 20%.

On the other end of AI spending, companies making significant investments are also facing stock price pressure. Since releasing its earnings report on October 29, Meta's stock has dropped 21% due to investor concerns over its aggressive capital expenditure plans, while Microsoft has also fallen 13% for similar reasons.

Companies with weaker balance sheets are feeling the brunt of the impact, with CoreWeave's stock plummeting over 40% this month, and Oracle's stock down 29%, potentially marking its largest single-month decline since 2001.

“For all those bearish on the bubble, they might say it’s a bit ‘premature’ for companies like Oracle and CoreWeave, as both need to borrow heavily to participate in this game,” Kevin Cook added.

Optimism and Skepticism: Deep Divisions on Wall Street

Currently, there is a clear divide in the market's view on the prospects of AI. Skeptics worry that investors, in pursuit of the growth of a few AI concept stocks, have pushed valuations to excessively high levels. They believe that the hundreds of billions of dollars spent by tech companies to remain competitive is unsustainable, especially as they begin to rely on debt to maintain their investments. Furthermore, the nature of this cyclical financing could pose systemic risks, where the weakness of one company could drag down the entire AI sector.

On the other hand, optimists see the recent pullback as a healthy correction in the process toward further growth. They believe that the tech giants at the core of AI trading—Microsoft, Amazon, Meta, and Alphabet—will continue to invest in their businesses, with no signs of slowing down in the short term. They argue that, given the strong demand in the industry and a relatively loose regulatory environment, the investment cycle for AI has only just begun.

“There is indeed a divide,” said Dec Mullarkey, Managing Director at SLC Management. “We have gone through a long bull market, and valuations are stretched, so there is a strong fear of an AI bubble bursting. But another group of investors is looking for stimulants that can extend the cycle, such as the prospect of Federal Reserve rate cuts, less regulation, and more mergers and IPO activity.”

Focus Shift: From Capital Expenditure to Return on Investment

NVIDIA's performance itself can be described as "outstanding." According to Daniel Pilling, Portfolio Manager at Sands Capital Management, its forward revenue guidance is 5% higher than market consensus. However, the market's focus has clearly shifted.

What investors are really starting to question is the other end of the spending—return on investment (ROI). Wall Street is now eager to know when this massive influx of capital will lead to faster growth and higher profitability for companies providing AI software and services. According to Mark Luschini, Chief Investment Strategist at Janney Montgomery Scott, the market needs to see clear evidence regarding ROI for AI trading to regain momentum.

“We may need another one or two quarters to see relevant evidence, and until then, this will remain a focal point for investors,” Luschini said. “As long as this question festers in the background, it could jeopardize the originally optimistic outlook for AI.”

Data shows that the four major clients—Microsoft, Amazon, Meta, and Alphabet—accounting for over 40% of NVIDIA's sales, are expected to increase their combined capital expenditures by 34% to $440 billion over the next 12 months. Kevin Cook, Senior Strategist at Zacks Investment Research, believes that although NVIDIA is the "key" to AI trading, its robust performance has not alleviated market concerns about these major buyers.

Bumpy Road Ahead: Volatility May Become the New Normal

At present, whether investors are "half-full" or "half-empty," they seem to have reached a consensus on one issue: the future path of AI trading will be bumpier B. Riley Wealth's Chief Market Strategist Art Hogan pointed out that the uncertainty in the macroeconomy and the divergence regarding the stage of the AI revolution together form the backdrop for recent market volatility. He stated, "I think all of this is part of the volatility we are seeing." As the market shifts from a frenzy of enthusiasm for AI to a more rational examination, volatility may become the new normal for the AI sector